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State of North Carolina
CORPORATE INCOME, FRANCHISE, AND INSURANCE TAX BULLETIN
Reflecting Changes Made in the 2016 Regular Session
of the North Carolina General Assembly
Issued by:
Corporate Tax Division
Tax Administration
North Carolina Department of Revenue
501 North Wilmington Street
Raleigh, North Carolina 27604
June 2017
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PREFACE
The Corporate Income, Franchise, and Insurance Tax Bulletin was prepared for the purpose of presenting the administrative interpretation and application of North Carolina corporate income, franchise, and insurance premiums tax laws at the time of publication. This publication supplements information provided in the Administrative Rules but does not supersede the Administrative Rules. In addition, this bulletin does not cover all provisions of the law.
Taxpayers are cautioned that this publication is intended merely as a guide and that consideration must be given to all the facts and circumstances in applying this Bulletin to particular situations. Taxpayers using this publication should be aware that additional changes may result from legislative action, court decisions, and rules adopted or amended under the Administrative Procedure Act, Chapter 150B of the General Statutes. To the extent there is any change to a statute, administrative rule, or new case law subsequent to the date of this publication, the provisions in this bulletin may be superseded or voided. Unless otherwise noted, this Bulletin is intended to reflect changes made in the 2016 regular session of the North Carolina General Assembly.
Revised June 2017
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TABLE OF CONTENTS
I. FRANCHISE TAX
A. General Information ………………………………………………………………….. p. 5
B. Holding Companies …………………………………………………………………... p. 7
C. General Business Corporations ………………………………………………………. p. 8
D. Net Worth Base ………………………………………………………………………. p. 10
E. Multistate Corporations ………………………………………………………………. p. 11
F. Investment in Tangible Property in North Carolina Base ……………………………. p. 12
G. Appraised Valuation of Tangible Property Base ……………………………………... p. 13
H. Corporate Members of LLCs …………………………………………………………. p. 13
I. Change of Income Year ………………………………………………………………. p. 15
J. Corporations Conditionally or Partially Exempt ……………………………………... p. 17
II. CORPORATE INCOME TAX
A. Corporations Subject to Tax, Tax Rate and Allocation Requirements ……………….. p. 19
B. Tax Credits ……………………………………………………………………………. p. 22
C. Computation of Net Income ………………………………………………………….. p. 22
D. Interest Income on Government Obligations ………………………………………… p. 29
E. Attribution of Expenses to Nontaxable Income and to ………………………………. p. 30
Nonapportionable Income and Property
F. Related Entity Interest Deduction Limitation ………………………………………… p. 32
G. Allocation and Apportionment Procedures …………………………………………… p. 33
H. Taxable in Another State ……………………………………………………………… p. 36
I. Apportionable and Nonapportionable Income ………………………………………... p. 38
J. Apportionment Factors ………………………………………………………………... p. 39
K. Deduction of Contributions …………………………………………………………… p. 55
L. Rapid Amortization of Equipment Mandated by OSHA ……………………………... p. 57
M. Amortization of Bond Premiums ……………………………………………………... p. 57
N. Net Economic Loss Carry-Over ………………………………………………………. p. 59
O. State Net Loss Deduction ……………………………………………………………... p. 65
P. Secretary’s Authority to Adjust Net Income or Require a Combined Return ………… p. 68
Q. Partnership and the Corporate Partner ………………………………………………… p. 75
R. Filing of Returns and Payment of Taxes ……………………………………………… p. 76
S. Extension of Time for Filing Return ………………………………………………….. p. 79
T. Dissolutions and Withdrawals ………………………………………………………… p. 79
U. Suspensions and Reinstatements ……………………………………………………… p. 80
V. Exempt Corporations …………………………………………………………………. p. 81
W. Reporting Federal Changes …………………………………………………………… p. 85
X. Domestic International Sales Corporation ……………………………………………. p. 87
Y. S Corporations ………………………………………………………………………… p. 88
Z. Qualified Subchapter S Subsidiaries ………………………………………………….. p. 89 4
III. INSURANCE PREMIUMS TAX
A. General Information …………………………………………………………………... p. 91
B. Insurance Companies Subject to the Tax under G.S 105-228.5 ……………………… p. 91
C. Captive Insurance Companies Subject to the Tax under G.S. 105-228.4A …………... p. 91
D. Types of Tax and Charges ……………………………………………………………. p. 91
E. Tax Basis for Insurers taxed under G.S. 105-228.5 …………………………………... p. 92
F. Tax Basis for Captive Insurers taxed under G.S. 105.228.4A ………………………... p. 93
G. Tax Rates and Charges ………………………………………………………………... p. 93
H. Tax Rates and Charges for Captive Insurance Companies …………………………… p. 94
I. Retaliatory Provisions ………………………………………………………………… p. 94
J. Installment Payments …………………………………………………………………. p. 95
K. Due Dates ……………………………………………………………………………... p. 95
L. Electronic Funds Transfer (EFT) Requirement ……………………………………….. p. 95
M. Exempt Insurance Companies ………………………………………………………… p. 96
N. Tax Credits ……………………………………………………………………………. p. 96
O. Insurance Tax Administered by Department of Insurance …………………………… p. 97
P. No Additional Local Taxes …………………………………………………………… p. 97
Q. Exemption From Franchise or Corporate Income Tax ……………………………….. p. 97
R. Penalties ………………………………………………………………………………. p. 97
IV. TAX CREDITS
A. Overview ……………………………………………………………………………… p. 99
B. Tax Credits (Article 4) ………………………………………………………………... p. 99
C. Tax Incentives for New and Expanding Businesses ………………………………….. p. 113
D. Business & Energy Tax Credits ………………………………………………………. p. 114
E. Tax Incentives for Recycling Facilities (Article 3C) …………………………………. p. 119
F. Historic Rehabilitation Tax Credits (Article 3D) …………………………………….. p. 121
G. Historic Rehabilitation Tax Credits (Article 3L) ……………………………………... p. 124
H. Low-Income Housing Tax Credits (Article 3E) ………………………………………. p. 128
I. Research and Development Tax Credit (Article 3F) ………………………………….. p. 134
J. Credit for Mill Rehabilitation (Article 3H) …………………………………………… p. 137
K. Tax Credits for Growing Businesses (Article 3J) …………………………………….. p. 140
L. Tax Incentive for Railroad Intermodal Facility (Article 3K) …………………………………. P. 140 5
I. FRANCHISE TAX
(Article 3)
A. General Information (G.S. 105-114)
1. Scope and Nature
North Carolina levies a series of franchise taxes upon corporations, both domestic and foreign, and upon certain persons, limited liability companies (“LLCs”), and partnerships. The taxes levied in this subchapter are for the privilege of engaging in business or doing the act named. Specific sections of the law under which the various corporations and businesses are taxed are as follows:
G.S. § 105-114.1 Limited liability companies
G.S. § 105-120.2 Holding companies
G.S. § 105-122 General business corporations
G.S. § 105-125 Exempt corporations
The taxes levied upon corporations organized under the laws of North Carolina (domestic corporations) are for the corporate rights and privileges granted by their charters, and the enjoyment of corporate powers, rights, privileges and immunities under the laws of North Carolina.
The taxes levied upon corporations not organized under the laws of North Carolina (foreign corporations) are for the privilege of doing business in this State and for the benefit and protection they receive from the government and laws of this State.
A corporation, other than a holding company taxed under G.S. § 105-120.2, that is subject to one of the franchise taxes other than the general business franchise tax, is subject to the general business franchise tax to the extent it exceeds the other franchise tax.
2. Corporation Defined
For franchise tax purposes, the term “corporation” includes not only corporations in the usual meaning of the term, but also associations, joint stock companies, trusts and other organizations formed or operating for pecuniary gain which have capital stock represented by shares and privileges not possessed by individuals or partnerships. The term includes limited liability companies that elect to be taxed as corporations for federal income tax purposes.
3. S Corporations
S corporations are liable for franchise tax levied under Article 3 of the Revenue Laws.
4. Period Covered 6
Taxes levied under this Article are for the fiscal year of the State in which they become due, except that the taxes levied are for the income year of the corporation in which such taxes become due.
5. Inactive Corporations (17 NCAC 05B.0104)
A corporation that is inactive and without assets is subject to an annual minimum franchise tax of two hundred dollars ($200). Failure to file this return and pay the minimum tax will result in the suspension of the Articles of Incorporation or Certificate of Authority. Any corporation that intends to dissolve or withdraw through suspension for nonpayment of franchise tax should indicate its intention in writing to the Department.
6. Voluntary Dissolution or Withdrawal of Corporate Rights (G.S. § 105-127(d))
Corporations are not subject to franchise tax after the end of the income year in which articles of dissolution or withdrawal are voluntarily filed with the Secretary of State unless they engage in business activities not reasonably incidental to winding up their affairs. Therefore, no franchise tax is required with the income tax return filed for the year in which the application is filed or with any subsequent income tax returns that may be required in connection with winding up the affairs of the corporation.
Example 1: A calendar year corporation voluntarily files articles of dissolution or withdrawal during the calendar year 2017. Although its final income tax return will be filed on a franchise and income tax return, the franchise tax portion of the return need not be completed since the franchise tax applicable to calendar year 2017 was calculated on the 2016 tax return.
Example 2: A corporation using an income year ending April 30 voluntarily files articles of dissolution or withdrawal on May 19, 2017. Although its final income tax return will be filed on a franchise and income tax return, the franchise tax portion of the return need not be completed since the franchise tax applicable to the income year beginning May 1, 2017, was calculated on the tax return for the income year ended April 30, 2017.
A corporation is not entitled to a partial refund of franchise tax paid if the corporation files articles of dissolution or withdrawal during the year.
7. Payment of Franchise Taxes (G.S. § 105-122(a))
Franchise tax is due on the statutory filing date of the return, without regard to extensions.
8. Extension of Filing Date (17 NCAC 05B.0107)
A corporation subject to the franchise tax may obtain an extension of time for filing its franchise tax return by filing Form CD-419 within the time required pursuant to G.S. § 105-263. Form CD-419 is available at: http://www.dor.state.nc.us/downloads/corporate.html. 7
An extension of time for filing a franchise tax return does not extend the time for paying the tax due or the time when a penalty attaches for failure to pay the tax. For additional detailed information concerning the requirements for obtaining an extension of time for filing a corporate franchise and income tax return, see “Extension of Time for Filing Return” in Section II, Corporate Income Tax.
9. Tax Credit for Limited Liability Companies Subject to Franchise Tax (G.S. § 105-122.1)
LLCs that elect to be taxed as corporations for federal income tax purposes are allowed a tax credit against franchise tax equal to the difference between the annual report fee on corporations for filing paper annual reports under G.S. § 55-1-22(a)(23) and the annual report fee for limited liability companies under G.S. § 57D-1-22. The credit allowed may not exceed the franchise tax liability for the year reduced by the sum of all credits allowed, except payments of tax made by or on behalf of the taxpayer.
Example. An LLC that has elected to be taxed as a corporation computes its franchise tax due to be $500. Because the fee under for an LLC under G.S. § 57D-1-22 is $200, while the fee for a corporation filing a paper annual report under G.S. § 55-1-22(a)(23) is $25, a credit of $175 is allowed to the LLC against franchise tax.
B. Holding Companies (G.S. § 105-120.2)
1. Definition
A holding company is any corporation that receives more than eighty percent (80%) of its gross income during its taxable year from corporations in which it owns, directly or indirectly, more than fifty percent (50%) of the outstanding voting stock or voting capital interest. A corporation will also qualify for holding company status if it has no assets other than ownership interests in corporations in which it owns, directly or indirectly, more than 50% of the outstanding stock or voting capital interests.
If a holding company has an ownership interest in an LLC doing business in the State and the LLC is taxed as a corporation for federal income tax purposes, the holding company’s share of the income of the LLC is included in the denominator and, if the corporation owns more than fifty percent (50%) of the voting capital interest in the LLC, the holding company’s share of the income of the LLC is included in the numerator when computing the holding company test.
2. Basis for Taxation
The basis of the tax for a holding company is the same as for general business corporations. However, franchise tax payable by a qualified holding company on its net worth base is limited to one hundred and fifty thousand dollars ($150,000). Any corporation that qualifies as a holding company for franchise tax should fill in the circle next to Line 1 on Page 1 of the appropriate form, CD-405 or CD-401S. There is no limitation on the amount of franchise tax 8
payable where the tax produced by the investment in tangible property or appraised value of property exceed the tax produced by the net worth base.
C. General Business Corporations (G.S. § 105-122)
1. Basis for the Tax
For years beginning on or after January 1, 2017, the basis of the tax is the net worth of the taxpayer. The basis is the same for both domestic and foreign corporations. Corporations doing business both within and without North Carolina are required to apportion their net worth to North Carolina in accordance with a specified statutory apportionment formula. Regardless of the actual amount of net worth, the amount determined for purposes of this tax cannot be less than fifty-five percent (55%) of appraised ad valorem tax value of all the real and tangible property in North Carolina or less than the actual investment in tangible property in North Carolina.
2. Franchise Tax Calculation
Franchise tax is calculated on the largest of the following amounts:
 The net worth tax base
 Fifty-five percent (55%) of appraised ad valorem tax value of all real and tangible property in N. C.
 Actual investment in tangible property in North Carolina
3. Corporations Required to File
Unless specifically exempt under G.S. § 105-125, all active and inactive domestic corporations, and all foreign corporations with a Certificate of Authority to do business, or which are in fact doing business in this State, are subject to the annual franchise tax levied under G.S. § 105-122.
If an LLC is taxed as a corporation for federal tax purposes and a corporate member’s only connection to North Carolina is its ownership interest in the LLC, the corporate member(s) is not required to file a North Carolina corporate income and franchise tax return. The corporate member(s) is not required to file in this circumstance because the LLC reports its North Carolina income at the entity level and the apportionment attributes of the LLC do not flow through to the corporate member(s) as is the case when the LLC is disregarded or is treated as a partnership.
If an LLC is taxed as a corporation for federal tax purposes and a corporate member has activities in this State in addition to its ownership interest in the LLC, the corporate member(s) is required to file a corporate income and franchise tax return.
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4. Forms to be Used for Filing
The franchise tax is filed on Form CD-405 for C corporations and Form CD-401S for S corporations. These forms, along with other required corporate forms and instructions, are available from the Department’s web site at:
http://www.dor.state.nc.us/downloads/corporate.html.
5. Substitute Returns
Any substitute form must be approved by the Department of Revenue prior to its use. The guidelines for producing substitute forms are available on the Department’s website. If a taxpayer uses computer-generated returns, the software company is responsible for requesting and receiving an assigned barcode. The Department publishes a list of software developers that have received approval on the Department’s web site. Photocopies of the return are not acceptable. Returns that cannot be processed by our imaging and scanning equipment may be returned to the taxpayer with instructions to refile on an acceptable form.
6. Report and Payment Due
Corporations must file returns annually on or before the fifteenth day of the fourth month following the end of the income year. The return is filed as a part of a joint franchise and income tax return. Payment of the entire amount of franchise tax is required by the statutory due date of the return.
7. Tax Rate
The franchise tax rate is one dollar and fifty cents ($1.50) per one thousand dollars ($1,000) and is applied as set forth in the law. The minimum franchise tax is two hundred dollars ($200).
8. Franchise Tax Payable in Advance (G.S. § 105-114)
Franchise tax is payable in advance for the privilege of doing business in North Carolina or for the privilege of existing as a corporation in North Carolina.
Example: A corporation incorporates, domesticates or commences business in North Carolina on October 15, 2016. The corporation has selected a calendar year end. The first tax return due on April 15, 2017 will be a short period return covering the income tax period from October 15, 2016 to December 31, 2016. Franchise tax due on this return covers the ensuing calendar year through December 31, 2017 for the privilege of doing business in North Carolina or for the privilege of existing as a corporation in North Carolina.
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D. Net Worth Base (G.S. § 105-122(b)) – (Applicable to Tax Years Beginning On or After January 1, 2017 calculated on 2016 and after income tax returns)
1. Based on Year End Balance Sheet
Net worth is measured as of the end of the taxable year using generally accepted accounting principles (“GAAP”). If the corporation does not use GAAP in maintaining its books and records, then net worth is computed using the same accounting method used for federal income tax purposes, so as long as this method fairly represents the corporation’s net worth for franchise tax purposes.
2. Net Worth Defined
A corporation’s net worth is defined as the total assets of the corporation without regard to deductions for accumulated depreciation, depletion, or amortization minus total liabilities.
3. Adjustments to Net Worth
In determining net worth, the following adjustments are required:
(a) A deduction for accumulated depreciation, depletion, or amortization allowed for federal income tax purposes.
(b) A deduction for the cost of treasury stock.
(c) An addition for the amount of affiliated indebtedness owed to a parent, subsidiary, affiliate, or noncorporate entity if the corporation or affiliated group directly or indirectly owns 50% or more of the noncorporate entity, other than debt that is merely endorsed, guaranteed or otherwise supported by the corporation or affiliated group of corporations.
The addition for affiliated indebtedness may be reduced based on the ratio of the borrowed capital over the total assets of the creditor corporation. Borrowed capital does not include indebtedness incurred by a bank from a deposit evidenced by a certificate of deposit, passbook, cashier’s check, certified check, or similar document or record.
(d) A creditor corporation that is subject to franchise tax may deduct the amount of indebtedness owed to it by a parent, subsidiary, or affiliated corporation to the extent such indebtedness has been added by the debtor corporation in computing its franchise tax liability.
4. Other Definitions
In determining the net worth base, the following definitions apply:
(a) Affiliate – A corporation is an affiliate of another corporation if it is controlled directly or indirectly by the same parent corporation or same or associated financial interests through 11
stock ownership, interlocking directors, or by any other means whatsoever, whether the control is direct or through one or more subsidiary, affiliate, or controlled corporation.
(b) Affiliated Group – The same meaning as defined in G.S. § 105-114.1.
(c) Capital Interest – The right under the entity’s governing law to receive a percentage of the entity’s assets, after payments to creditors, if the entity were dissolved.
(d) Governing Law – The law under which the noncorporate entity was organized.
(e) Indebtedness – All loans, credits, goods, supplies, or other capital of whatsoever nature furnished by a parent, a subsidiary, an affiliate, or a noncorporate entity in which the corporation or an affiliated group of corporations owns directly or indirectly more than 50% of the capital interests of the noncorporate entity. Indebtedness does not include amount endorsed, guaranteed, or otherwise supported by one of the related corporations.
(f) Noncorporate entity – a person that is neither a human being nor a corporation.
(g) Parent – A corporation that directly or indirectly controls another corporation by stock ownership, interlocking directors, or by any other means whatsoever exercised by the same or associated financial interests, whether such control is direct or through one or more subsidiary, affiliated, or controlled corporations.
(h) Subsidiary – A corporation that is directly or indirectly subject to control by another corporation by stock ownership, interlocking directors, or by any other means whatsoever exercised by the same or associated financial interest, whether the control is direct or through one or more subsidiary, affiliated, or controlled corporations.
(i) Total assets – The sum of all cash, investments, furniture, fixtures, equipment, receivables, intangibles, and any other items of value owned by a person or a business entity.
E. Multistate Corporations (G.S. § 105-122(c1))
1. Apportionment Formula
Every corporation permitted to apportion its net income for income tax purposes under the provisions of G.S. § 105-130.4 must apportion its net worth for franchise tax purposes through use of the same fraction computed for apportionment of its apportionable income under G.S. § 105-130.4. A corporation that is subject to the general business franchise tax, but exempt from income tax, must apportion its net worth by using the apportionment factor it would have used had it been subject to the income tax. Adjustments in the method of apportionment authorized by the Secretary of Revenue for apportionment of net income do not apply automatically to apportionment of net worth. Unless the Secretary specifically authorizes a modified method of allocation for franchise tax purposes, the statutory formula must be used.
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2. Alternate Apportionment Formula
If any corporation believes that the statutory apportionment formula allocates more of its net worth to North Carolina than is reasonably attributable to its business in this State, it may make a written request to the Secretary of Revenue for permission to use an alternative formula which it believes is a better method to apportion its net worth to North Carolina.
The written request must be made with the Secretary not later than ninety (90) days after the regular or extended due date of the tax return. Taxpayers should address all correspondence in connection with such petitions to the Secretary of the Revenue.
The Secretary must issue a written decision on a corporation’s request for an alternative apportionment method. The decision can apply to no more than three years. If the request is denied, the Secretary’s decision is final and is not subject to administrative or judicial review. A corporation authorized to use an alternative formula may apportion its net worth base using the alternative method or the statutory method.
F. Investment in Tangible Property in North Carolina Base (G.S. § 105-122(d))
1. Basis For the Investment Base
This base includes the original purchase price plus additions and improvements and less reserve for depreciation permitted for income tax purposes of all tangible property, including real estate located in North Carolina at the end of the income year immediately preceding the due date of the return.
2. What is Includable in the Investment Base (17 NCAC 05B.1302)
Include all tangible assets located in North Carolina at original purchase price less reserve for depreciation permitted for income tax purposes. In addition to the types of property listed in the schedule, include all other tangible property owned such as supplies and tools. Typical items of tangible property would include: inventory (valued at actual cost or by method consistent with the actual flow of goods), consigned inventories to be included by consignor, machinery and equipment, furniture and fixtures, containers, tools and supplies, land, buildings, leasehold improvements, and all other tangible assets.
3. Treatment of Construction in Progress (17 NCAC 05B.1303)
Construction in progress is excluded from this base only if such property is not owned by the corporation filing the return.
4. Determination of Inclusion Based on Depreciation Deduction (17 NCAC 05B.1309)
When two or more corporations are in doubt as to which should include property, including leased property, in the investment in tangible property base, such property shall be included by the corporation allowed depreciation under the Federal Code. 13
5. Holding Company
There is no limitation on the franchise tax payable by a holding company on its investment in tangible property tax base.
G. Appraised Valuation of Tangible Property Base (G.S. § 105-122(d), 17 NCAC 05B.1406)
Tangible property values for this base are computed on fifty-five percent (55%) of the appraised value of all property listed for county ad valorem tax in North Carolina as of January 1 of the calendar year next preceding the due date of the return.
Note: Also included in the appraised value of property for county ad valorem tax is the appraised value of all vehicles for which the county tax assessor has issued a billing during the income year.
There is no limitation on the franchise tax payable by a holding company on its appraised valuation of property tax base.
H. Corporate Members of LLCs (G.S. § 105-114.1)
(This section does not apply to limited liability companies that are taxed as corporations, but does apply to noncorporate limited liability companies, i.e., limited liability companies that do not elect to be taxed as corporations under the Code.)
If a corporation or affiliated group of corporations owns, directly or constructively, more than fifty percent (50%) of the capital interests in an LLC, the corporation or group of corporations must include the same percentage of the LLC’s assets in its three franchise tax bases. In that case, the corporation’s investment in the LLC is not included in the calculation of the corporation’s capital stock, surplus and undivided profits base. The attribution to the three bases is equal to the same percentage of (1) the LLC’s capital stock, surplus and undivided profits, (2) fifty-five percent (55%) of the LLC’s appraised ad valorem tax value of property, and (3) the LLC’s actual investment in tangible property in this State.
Exception – if the total book value of the LLC’s assets never exceeds one hundred fifty thousand dollars ($150,000) during its taxable year, no attribution is required.
When a partnership, trust, LLC, or other entity is placed between a corporation and an LLC, ownership of the capital interests in an LLC is determined under the constructive ownership rules for partnerships, estates, and trusts in IRC § 318(a)(2)(A) and (B), modified as follows:
 The term “capital interest” is substituted for “stock” where that term appears in the referenced Code section.
 An LLC and any entity other than a partnership, estate or trust is treated as a partnership. 14
 The operating rule of section 318(a)(5) applies without regard to section 318(a)(5)(C).
Example: A partnership owns one hundred percent (100%) of the capital interests of an LLC. Corporation A is a fifty percent (50%) owner of the partnership. Corporation A constructively owns fifty percent (50%) of the capital interest in the LLC.
The members of an affiliated group must determine the percentage of the LLC’s assets to be included in each member’s franchise tax bases. If all members of the group are doing business in North Carolina, then the percentage of the LLC’s assets included by each member in its franchise tax bases is equal to the member’s percentage ownership in the LLC. If some of the members of the group are not doing business in North Carolina, then the percentage of the LLC’s assets owned by the group are allocated among the members that are doing business in North Carolina. The percentage attributed to each member doing business in North Carolina is determined by multiplying the percentage of the LLC owned by the entire group by a fraction. The numerator of the fraction is the percentage of the LLC owned by the member and the denominator is the total percentage of the LLC owned by all members doing business in North Carolina.
If the owner of the capital interests in an LLC is an affiliated group of corporations, the percentage to be included by each member that is doing business in this State is determined by multiplying the capital interests in the LLC owned by the affiliated group by a fraction. The numerator of the fraction is the capital interests of the LLC owned by the group member, and the denominator is the capital interests in the LLC owned by all group members that are doing business in this State.
Ownership of the capital interests in an LLC is determined under the constructive ownership rules for partnerships, estates, and trusts in IRC § 318(a)(2)(A) and (B), modified as follows:
 The term “capital interest” is substituted for “stock” where that term appears in the referenced Code section.
 A LLC and any entity other than a partnership, estate, or trust is treated as a partnership.
 The operating rule of section 318(a)(5) of the Code applies without regard to section 318(a)(5)(C).
Example: An affiliated group of corporations own one hundred percent (100%) of the capital interests in an LLC. The group consists of three corporations. Corporation A is doing business in North Carolina and owns fifty percent (50%) of the LLC. Corporation B is doing business in North Carolina and owns ten percent (10%) of the LLC. Corporation C is not doing business in North Carolina and owns forty percent (40%) of the LLC. The percentage of the LLC’s assets required to be included in Corporation A’s and Corporation B’s franchise tax bases is determined as follows:
Corporation A: 100% X 50%  (50% + 10%) = 83.33%
Corporation B: 100% X 10%  (50% + 10%) = 16.67%
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A corporation that is required to include a percentage of the LLC’s assets in its franchise tax computation may exclude its investment in the LLC from its computation of the net worth base.
Shifting assets back and forth between a corporation and an LLC to avoid franchise tax is prohibited. Ownership of the capital interests in an LLC is determined as of the last day of the LLC’s taxable year. The attribution of the LLC’s assets and the exclusion of the corporation’s investment in the LLC are made to the corporation’s next following franchise tax return. However, if the corporation and LLC engage in a pattern of transferring assets between them so that each did not own the assets on the last day of its taxable year, the ownership of the capital interest in the LLC must be determined as of the last day of the corporation’s taxable year.
Any taxpayer who, because of fraud with intent to evade tax, underpays the tax under this Article (G.S. 105 Article 3) is guilty of a Class H felony in accordance with G.S. 105-236(7). For additional information on the filing requirements for members of LLCs, see Item 5, Subsection J “Corporations Conditionally or Partially Exempt.”
I. Change of Income Year (105-122(e))
1. Computation of Tax (17 NCAC 05B.1501)
A change in income year automatically establishes a new franchise year. A joint franchise and income tax return is required for the short income period. Credit is permitted on such return against the franchise tax to the extent that the new franchise year overlaps the old year.
Example: A corporation changes its income year from a calendar year to one ending July 31. A combined franchise and income return is required for the short period January 1, 2017 through July 31, 2017 (seven (7) months). Franchise tax paid on the 2016 return applicable to the calendar year 2017 was $240. Franchise tax on the short period would be applicable to the year August 1, 2017 through July 31, 2018, and would be computed as follows:
Total tax due per return $268
Less credit for portion of prior year’s tax:
Total tax paid on 2006 return $240
Less amount applicable to short period (7/12 of $240) 140
Amount applicable beyond short period 100
Net franchise tax due on short period return $168
G.S. § 105-129.5(b) applies in computing the net franchise tax due for the short period. The statutorily computed tax is reduced by current installments and carryforwards of available tax credits, subject to the fifty percent (50%) limitation, before calculating the amount applicable to the short period and the amount applicable beyond the short period.
2. Computation of Tax When Merger is Involved (17 NCAC 05B.1502)
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Often when two corporations merge, a question arises concerning which corporation is liable for the franchise tax. If the merger is effective at any time after the close of the submerged corporation’s year-end, then the submerged corporation is liable for the tax. If the merger is effective at any time prior to the close of the submerged corporation’s year-end, then the surviving corporation is liable for the tax.
Since franchise tax is paid prospectively, a special computation is sometimes required to prevent a duplication of tax when two or more corporations with different income years merge or otherwise transfer the entire assets from one corporation to the other. The following example illustrates the conditions under which this occurs.
Example: ABC Corporation, whose income year ends July 31, merged into XYZ Corporation, whose income year is the calendar year. The merger occurred on October 31, 2016. ABC filed a combination franchise and income tax return for the year ended July 31, 2016 and paid franchise tax of six hundred dollars ($600) applicable to the ensuing year ending July 31, 2017. XYZ filed a combination franchise and income tax return for the calendar year 2016 and paid franchise tax of seven hundred dollars ($700) applicable to the ensuing calendar year 2017. The assets reflected in ABC’s tax base were also reflected in XYZ’s tax base since they had been transferred to XYZ in the merger, and therefore, were on its books as of the end of its income year, December 31, 2016. The year to which ABC’s payment applied overlapped the year to which XYZ’s payment applied by seven months (January 1, 2017 through July 31, 2017) and reflected a duplication of tax to that extent.
When the conditions illustrated in the above example exist, where, the acquiring corporation acquired the entire assets of the disposing corporation, the acquiring and disposing corporations had different income years, the date of merger or transfer was after the end of the disposing corporation’s income year next preceding such transfer but before the beginning of the surviving corporation’s income year next following such transfers, and the disposing corporation had paid franchise tax applicable to its income year in which the transfer occurred, the acquiring corporation may compute its franchise tax on its franchise and income tax return for the income year in which the transfer occurred as shown in the following example:
Franchise tax per surviving corporation’s return for
income year in which transfer occurred $700
Less: Franchise tax paid by submerged corporation per return
for income year immediately preceding transfer $600
Number of months between the ending dates
on the above returns 5
Number of months in year 12 x $600 = 250
Amount pertaining to overlapping months $350
Net franchise tax due $350 17
J. Corporations Conditionally or Partially Exempt (G.S. § 105-122, G.S. § 105-125)
1. Non-Profit Organizations
The following organizations and any other organization exempt from federal income tax under the Code are exempt from franchise tax if they are not organized for profit and if no profit inures to the benefit of any member, shareholder or other individual:
a. Fraternal societies, orders or associations. To qualify for income tax exemption, the organization must operate under the lodge system or for the exclusive benefit of members of a fraternity that is operating under the lodge system, and provide life, sick, accident or other benefits to the members or their dependents.
b. Corporations organized or trusts created for religious, charitable, scientific or educational purposes, including cemetery corporations and organizations for the prevention of cruelty to children and animals.
c. Business leagues, chambers of commerce, merchants associations and boards of trade.
d. Civic leagues or organizations operated exclusively for the promotion of civic welfare.
e. Clubs organized and operated exclusively for pleasure, recreation and other non-profit purposes.
f. Mutual hail, cyclone and fire insurance companies; mutual ditch, irrigation, canning and breeding associations; mutual or cooperative telephone companies; and like organizations of a purely local character which derive their entire income from assessments, dues or fees collected from members for the sole purpose of meeting expenses.
g. Farmer’s marketing associations operating as sales agents to market the products of members or other farmers, and to return to them the proceeds, less the necessary selling expenses, on the basis of the quantity of product furnished by them.
h. Pension, profit-sharing, stock bonus and annuity trusts established by employers for the purpose of distributing both the principal and income thereof exclusively to eligible employees or the beneficiaries of such employees. There must be no discrimination in favor of any particular employee. The interest of individual employees must be irrevocable and nonforfeitable to the extent of contributions by such employees. Exemption of a trust under the Federal income tax law is a prima facie basis for granting exemption from North Carolina franchise and income taxation.
i. Condominium associations, homeowner associations or cooperative housing corporations not organized for profit, the membership of which is limited to the owners or occupants of 18
residential units in the condominium, housing development, or cooperative housing corporation.
j. Cooperative or mutual associations formed under Section 54-124 of the General Statutes to conduct agricultural business on the mutual plan, and marketing associations formed under Section 54-129 of the General Statutes, are exempt from franchise tax.
2. Corporations Fully Exempt
These corporations qualify for the full franchise tax exemption:
 Insurance companies subject to the tax on gross premiums are exempt from the general business franchise tax.
 Telephone membership corporations organized under Chapter 117 of the General Statutes of North Carolina are exempt from the general business franchise tax. Electric membership corporations are, however, subject to franchise tax.
3. Regulated Investment Companies (RIC) and Real Estate Investment Trusts (REIT)
These organizations are required to pay franchise tax; however, in determining net worth they are allowed to deduct the aggregate market value of investments in the stock, bonds, debentures, or other securities or evidences of debt of other corporations, partnerships, individuals, municipalities, governmental agencies or governments. Captive REITs are not allowed this deduction. A captive REIT is a REIT whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are owned or controlled, at any time during the last half of the tax year, by a person that is subject to tax under this Part and is not a trust or another entity that qualifies as a real estate investment trust under section 856 of the Code or a listed Australian property.
4. Real Estate Mortgage Investment Conduits (REMIC)
These organizations are exempt from franchise tax to the extent the REMIC is exempt from income tax under the Code.
5. Limited Liability Company (LLC)
The “North Carolina Limited Liability Company Act” (Chapter 57C of the North Carolina General Statutes) permits the organization and operation of limited liability companies (LLC). An LLC is a business entity that combines the S corporation characteristic of limited liability with the flow-through features of a partnership. Noncorporate limited liability companies are not subject to the franchise tax. A noncorporate limited liability company is an LLC that does not elect to be taxed as a corporation under the Code.
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II. CORPORATE INCOME TAX
(Article 4 – Part 1)
A. Corporations Subject to Tax, Tax Rate and Allocation Requirements
(G.S. §§ 105-130.3 and 105-130.4)
1. Domestic and Foreign Corporations Required to File (17 NCAC 05C.0101)
All domestic corporations (those organized in North Carolina), and all foreign corporations (those organized outside North Carolina) with a certificate of authority to do business or doing business in North Carolina, are subject to income tax and are required to file annual income tax returns, except corporations specifically exempt from the tax under G.S. § 105-130.11, and S corporations exempt under G.S. § 105-131.1.
Because of a difference between the State income tax laws and the laws under the North Carolina Business Corporation Act, a foreign corporation operating in North Carolina may be liable for income tax even if not be required to obtain a certificate of authority to do business in North Carolina. For example, a Virginia corporation engaged in the general contracting business, which obtains a single, isolated job in North Carolina to be completed within six months, may not be required to obtain a certificate of authority to do business in this State under the Business Corporation Act but would be subject to income tax.
Note: A corporation organized in North Carolina or with a certificate of authority to do business in North Carolina must file an income tax return as a matter of record, even if the corporation was inactive or did not earn any net income in the tax year.
2. “Doing Business” Defined (17 NCAC 05C.0102)
For income tax purposes, the term “doing business” means the operation of any business enterprise or activity in North Carolina for economic gain, including, but not limited to, the following:
a. The maintenance of an office or other place of business in North Carolina;
b. The maintenance in North Carolina of an inventory of merchandise or material for sale, distribution or manufacture, regardless of whether kept on the premises of the taxpayer or in a public or rented warehouse;
c. The selling or distributing of merchandise to customers in North Carolina directly from a company-owned or operated vehicle when title to the merchandise is transferred from the seller or distributor to the customer at the time of the sale or distribution;
d. The rendering of a service to clients or customers in North Carolina by agents or employees of a foreign corporation; or 20
e. The owning, renting, or operating of business or income producing property in North Carolina including, but not limited to, the following:
 Realty;
 Tangible personal property;
 Trademarks, trade names, franchise rights, computer programs, copyrights, patented processes, licenses.
Corporations who are partners in a partnership or joint venture operating in North Carolina are considered to be “doing business” in the State.
“Doing business” by an interstate motor carrier is defined as the performance of any of the following business activities in North Carolina:
 The maintenance of an office in the State;
 The operation of a terminal or other place of business in the State;
 Having an employee working out of the office or terminal of another company;
 Dropping off or gathering up shipments in the State.
3. Corporations Operating in Interstate Commerce (17 NCAC 05C.0103)
The fact that a foreign corporation’s activities or operations in North Carolina are a part of its overall interstate business does not exempt the corporation from income tax liability. A corporation doing business in North Carolina as outlined above is subject to income tax even if its only operations in this State are a part of its interstate business. A foreign corporation not domesticated in North Carolina whose only activity in this State is the solicitation of sales of tangible personal property by either resident or nonresident salesmen is not required to file income tax returns under the Department’s current policy. However, if such a corporation maintains an office or other place of business in North Carolina, owns business property in this State, or meets the doing business definition, it is subject to the tax.
4. Tax Rate and Basis for the Tax (G.S. § 105-130.3, G.S. § 105-130.3C, G.S. § 105-130.4)
An income tax is levied on the State net income of all corporations chartered or doing business in North Carolina unless they are specifically exempt from tax under G.S. §§ 105-130.11 and 105-131.1. State net income is taxable income as defined in the Internal Revenue Code (“Code”) in effect for the income year for which the returns are to be filed, subject to the adjustments provided in G.S. § 105-130.5. The rates are as provided below:
Tax Year Beginning on or after Tax Rate
1/1/2014 6.0%
1/1/2015 5.0%
1/1/2016 4.0%
1/1/2017 3.0%
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In the case of a corporation that has business operations both within and without North Carolina; its net taxable income shall be allocated and apportioned to this State in accordance with G.S. § 105-130.4.
5. Corporations Required to Allocate and Apportion Income (G.S. § 105-130.4, 17 NCAC 05C.0601 and .0701)
A corporation must have business income from North Carolina and at least one other state to apportion and allocate its income. When a corporation is only taxable in another state as a result of nonapportionable income, then all apportionable income is attributed to North Carolina.
A corporation taxable both within and without North Carolina is required to use the allocation and apportionment provisions of G.S. § 105-130.4 to calculate its net income or net loss to North Carolina. For purposes of allocation and apportionment, a corporation is taxable in another state if:
 The corporation’s business activity in that state subjects it to a net income tax or a tax measured by net income; or
 That state has jurisdiction based on the corporation’s business activity in that state to subject the corporation to a tax measured by net income regardless of whether that state exercises its jurisdiction.
“Business activity” includes any activity by a corporation that would establish a taxable nexus pursuant to 15 United States Code, Section 381 (P.L. 86-272), based on North Carolina standards for doing business in this State. The filing of a unitary-combined return in another state with other related corporations does not, by itself, constitute “business activity” for purposes of determining if a corporation subject to income tax in this state is allowed to allocate and apportion income.
6. When in Doubt as to Liability
Any foreign corporation operating in North Carolina that is not certain of its tax status should promptly apply to the Department for a determination of its status. Complete detailed information as to the corporation’s operations should be submitted. All correspondence concerning the matter should be addressed to the Voluntary Disclosure Program, N.C. Department of Revenue, P.O. Box 871, Raleigh, N.C. 27602-0871.
7. Tax Forms
Corporation tax returns, Form CD-405 or Form CD-401S, are available from the Department’s web site at:
http://www.dornc.com/downloads/corporate.html.
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B. Tax Credits
Taxpayers are allowed various tax credits in Chapter 105 of the General Statutes that could be used to reduce corporate income tax (for credits applicable to Franchise Tax, see the Franchise Tax section of the 2017 Technical Bulletins). The following is a list of income tax credits that were repealed effective for tax years beginning on or after January 1, 2015:
 Credit for Rehabilitating Income-Producing Historic Structure - G.S. § 105-129.35
 Credit for Rehabilitating Nonincome-Producing Historic Structure - G.S. § 105-129.36
 Credit for Low Income Housing Awarded a Federal Credit Allocated on or after January 1, 2003 - G.S. § 105-129.42
 Credit for Income-Producing Rehabilitated Mill Property - G.S. § 105-129.71
 Credit for Nonincome-Producing Rehabilitated Mill Property - G.S. § 105-129.72
 Credit for Qualifying Expenses of a Production Company - G.S. §§ 105-130.47 and 105-151.29
These credits expired for tax years beginning on or after January 1, 2015.
 Credit for Investing in Renewable Energy Property - G.S. § 105-129.16A
 Credit for Donating to a Nonprofit Organization to Acquire Renewable Energy Property - G.S. § 105-129.16H
 North Carolina Research & Development - G.S. § 105-129.55
These credits expired for tax years beginning on or after January 1, 2016.
 Credit for Manufacturing Cigarettes for Exportation - G.S. § 105-130.45
 Credit for Manufacturing Cigarettes for Exportation While Increasing Employment and Utilizing State Ports - G.S. § 105-130.46
This credit will expire for tax years beginning on or after January 1, 2018.
- Credit for Constructing a Railroad Intermodal Facility - G.S. § 105-129.96
This credit will expire for tax years beginning on or after January 1, 2038.
For more specific information on these and the Article 3L Credit for Rehabilitation Income and Non-Income Producing Historic Property, see the Tax Credits section of the 2017 Technical Bulletins.
C. Computation of Net Income (G.S. §§ 105-130.3 and G.S. 105-130.5)
1. Preliminary Statement
A corporation uses its federal taxable income, as defined in the Code in effect for the tax year for which the return is to be filed, as its beginning point and adds or deducts the items listed below to compute State net income or loss. 23
A corporation may attach a copy of its Federal income tax return and supporting schedules in lieu of completing the corresponding schedules in its State return.
2. Adjustments to Federal Taxable Income
The following additions to Federal taxable income must be made in determining State net income:
a..Taxes based on or measured by net income by whatever name called and excess profits taxes.
b. Interest paid in connection with income exempt from State income taxation. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property.”
c. The contributions deduction allowed by the Internal Revenue Code.
d. Interest income earned on bonds and other obligations of other states or their political subdivisions, less allowable amortization on any bond acquired on or after January 1, 1963.
e. The amount by which gains have been offset by the capital loss carryover allowed under the Internal Revenue Code. All gains recognized on the sale or other disposition of assets are included in determining State net income or loss in the year of disposition.
f. Any amount allowed as a net operating loss deduction allowed by the Internal Revenue Code.
g. Payments to or charges by a parent, subsidiary or affiliated corporation in excess of fair compensation in any intercompany transaction.
h. The amount of all income tax credits claimed against the corporation’s income tax liability during the income year. In lieu of the add-back of tax credits to federal taxable income, taxpayers must reduce the amount of credit available by the current income tax rate. See Form CD-425, available at:
http://www.dor.state.nc.us/downloads/corporate.html.
i. Percentage depletion in excess of cost depletion applicable to mines, oil and gas wells and other natural deposits located outside this State.
j. The amount allowed under the Code for depreciation or as an expense in lieu of depreciation for a utility plant acquired by a natural gas local distribution company, to the extent the plant is included in the company’s rate base at zero cost in accordance with G.S. § 62-158.
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k. Royalty payments for the use of intangible property in this State made to a related member and deducted as an expense by a payer in arriving at federal taxable income if the election is made under G.S. § 105-130.7A for the recipient to exclude the royalty income from its income. A taxpayer making this election does not relieve the recipient from filing a North Carolina income tax return or apportioning royalty income pursuant to G.S. 105-130.4.
For purposes of G.S. § 105-130.7A, intangible property is defined as copyrights, patents, and trademarks. A taxpayer is not required to add back royalty payments for the use of intangible property in this State to a related recipient if the related recipient is organized under the laws of another country, that country has a comprehensive income tax treaty with the United States, and that country imposes a tax on the royalty income of the recipient at a rate that is equal to or exceeds the State’s corporate income tax rate.
l. The gross income from international shipping activities excluded from federal taxable income because the corporation elects to be subject instead to a tonnage tax under subchapter R of Chapter 1 of the Code.
m. The gross income from domestic production activities excluded from federal taxable income under section 199 of the Code.
n. The dividends paid deduction allowed to a captive Real Estate Investment Trust (“REIT”). A captive REIT is one whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are more than fifty percent (50%) owned or controlled by a person subject to North Carolina corporate income tax. REITs owned by other REITs or listed Australian property trusts are excluded from the definition.
o. The amount of a donation to a nonprofit organization or a unit of State or local government for acquisition or lease of renewable energy property made by a taxpayer who claimed a tax credit under G.S. § 105-129.16H.
p. The amount of income deferred under section 108(i)(1) of the Code from discharge of indebtedness in connection with a reacquisition of an applicable debt instrument.
q. The amount allowed as a deduction under section 163(e)(5)(F) of the Code for an original issue discount on an applicable high yield discount obligation.
r. The amount required to be added under G.S. § 105-130.5B when the State decouples from federal accelerated depreciation and expensing. See section 4, Adjustments When State Decouples From Bonus Depreciation and Section 179 Expenses.
s. The amount of net interest expense as determined under G.S. § 105-130.7B.
The following deductions from Federal taxable income must be made in determining State net income:
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a. Interest from obligations of the United States or its possessions, net of related expenses, to the extent included in federal taxable income. However, interest on obligations of the United States shall not be an allowable deduction unless interest from obligations of the State of North Carolina or any of its political subdivisions is exempt from income tax imposed by the United States.
b. Interest (net of expenses) received from obligations of the State of North Carolina, a political subdivision of this State, a commission, authority, or another agency of this State, a nonprofit educational institution organized or chartered under the laws of this State, and a hospital authority created under G.S. § 131E-17, to the extent the amounts are included in federal taxable income.
c. Payments received from a parent, subsidiary, or affiliated corporation in excess of fair compensation in intercompany transactions which were not allowed as a deduction for North Carolina income tax purposes by such corporation(s).
d. Dividends treated as received from sources outside the United States, as determined under section 862 of the Code, net of related expenses, to the extent included in federal taxable income. The netting of related expenses is calculated in accordance with G.S. §§ 105-130.5(c)(3) and 105-130.6A.
e. Any amount included in federal taxable income under section 78 or section 951 of the Code, net of related expenses.
f. For years prior to those beginning on or after January 1, 2015, net economic losses incurred by the corporation in any or all of the fifteen (15) preceding years pursuant to the provisions of G.S. § 105-130.8. For tax years beginning on or after January 1, 2015, state net losses are calculated under the provisions of G.S. § 105-130.8A. For specific instructions with respect to net economic loss and state net loss determinations see Subject: “State Net Loss Deduction and Net Economic Loss Carry-Over.”
g. Contributions or gifts made by the corporation within the income year to the extent provided under G.S. § 105-130.9. See Subject: “Deduction of Contributions.”
h. The amount of losses realized on the sale or other disposition of assets not allowed under section 1211(a) of the Internal Revenue Code. All losses recognized on the sale or other disposition of assets must be included in determining State net income or loss in the year of disposition.
i. The portion of undistributed capital gains of regulated investment companies included in federal taxable income and on which the federal tax paid by the regulated investment company is allowed as a credit or refund to the shareholder under section 852 of the Internal Revenue Code.
j. The amount by which the basis of a depreciable asset has been reduced on account of a tax credit allowed for federal tax purposes or a Section 1603 grant. 26
k. The amount of natural gas expansion surcharges collected by a natural gas local distribution company under G.S. § 62-158.
l. To the extent included in federal taxable income, the amount of 911 charges imposed under G.S. § 62A-43 and remitted to the 911 Fund under that section.
m. Royalty payments received for the use of intangible property in this State by a recipient from a payer that is a related member, if the election is made under G.S. § 105-130.7A for the payer to exclude the royalty payments from its expenses deduction. For purposes of G.S. § 105-130.7A, intangible property is defined as copyrights, patents, and trademarks.
n. The amount of dividend received from a captive Real Estate Investment Trust. A captive REIT is one whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are more than fifty percent (50%) owned or controlled by a person subject to NC corporate income tax. REITs owned by other REITs or listed Australian property trusts are excluded from the definition.
o. The amount of deferred income added to federal taxable income under IRC section 108(i)(1).
p. The amount allowed as a deduction under G.S. § 105-130.5B resulting from the add-back of federal income tax accelerated depreciation or expensing of assets. See section 4, Adjustments When State Decouples from Bonus Depreciation and Expensing.
q. The amount of qualified interest expense to a related member as determined under G.S. § 105-130.7B.
Other adjustments to Federal taxable income that must be made in determining State net income are listed below:
a. In determining State net income, no deduction shall be allowed for annual amortization of bond premiums applicable to any bond acquired prior to January 1, 1963. The amount of premium paid on any such bond shall be deductible only in the year of sale or other disposition.
b. Federal taxable income must be increased or decreased to account for any difference in the amount of depreciation, amortization, or gains or losses applicable to property that has been depreciated or amortized by use of a different basis or rate for State income tax purposes than used for federal income tax purposes prior to January 1, 1967.
c. No deduction is allowed for any direct or indirect expenses related to income not taxed, except no adjustment is made under this subsection for adjustments addressed in G.S. §§ 105-130.5(a) and (b). See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property.”
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d. Federal taxable income must be adjusted in instances where the taxable income change caused by the recovery of previously deducted amounts may be different for state income tax purposes.
e. Depreciation recapture under Federal provisions must also be included in State net income. Since depreciation recapture is included in the corporation’s federal taxable income, no adjustment is necessary in computing its State net income.
3. Unrealized Income from Installment Sales Taxable upon Termination of Business
A corporation that withdraws, dissolves, merges, or consolidates its business, or terminates its business in this State by any other means whatsoever is required to file a final income tax return within one hundred five (105) days after the close of business. If the corporation uses the installment method of reporting income, all unrealized or unreported income from installment sales made while doing business in this State must be included in State net income on the final return.
4. Adjustments When State Decouples from Bonus Depreciation and Section 179 Expensing (G.S. § 105-130.5B)
a. General
North Carolina law differs from the Code with respect to bonus depreciation under sections 168(k) and (n). In addition, adjustments may be required for amounts deducted under section 179 of the Code. For tax years beginning on or after January 1, 2013 taxpayers are required to make a bonus asset basis adjustment if an asset is transferred and the tax basis of the asset carries over from the transferor to the transferee for federal income tax purposes.
b. Bonus Depreciation Deduction
Taxpayers cannot deduct the full amount of bonus depreciation deduction for federal income tax purposes in the year allowed under sections 168(k) and (n). Instead (except for property placed into service in 2009 discussed below), taxpayers are required to add back eighty-five percent (85%) of the federal bonus deprecation in the year taken for federal income tax. Taxpayers may deduct 20% of the total amount of bonus depreciation added to federal taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back into income. Thus, the federal bonus depreciation deduction is spread over six taxable years for North Carolina income tax purposes.
Taxpayers that placed property in service in 2009 and took bonus depreciation under section 168(k) in 2009 are required to treat these amounts as placed into service in 2010, and add-back 85% of the bonus depreciation taken in the 2009 tax year to it federal taxable income for the 2010 income tax year. Subsequently, beginning with for tax year 2011, taxpayers are allowed to deduct 20% of the amount of bonus depreciation added to taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back in income for the five tax years following 2010. 28
The adjustments do not result in a basis difference for federal and State income tax purposes, except as discussed in Section d, below.
c. Section 179 Expenses
For tax years 2010 through 2014, North Carolina did not entirely conform to section 179 expensing allowed for federal income tax purposes. Instead, North Carolina had separate dollar and investment limitations, as follows:
Tax Year NC Dollar Limitation NC Investment Limitation
2010 $ 250,000 $ 800,000
2011 $ 250,000 $ 800,000
2012 $ 250,000 $ 800,000
For tax years beginning on or after 2013, the NC Dollar Limitation is $25,000 and the NC Investment Limitation is $200,000.
Taxpayers placing section 179 property into service during these years are required to add to federal taxable income 85% of the section 179 deductions in excess of the amount allowed using the North Carolina limits. Taxpayers may subsequently deduct 20% of the amount of bonus depreciation added to taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back into income.
The adjustments do not result in a basis difference for federal and State income tax purposes, except as discussed in Section d, below.
For additional information regarding section 179 expenses, see:
http://www.dornc.com/taxes/individual/impnotice062014.pdf
d. Bonus Asset Basis Adjustments
A bonus asset basis adjustment is required when the following occurs:
a) There is an actual or deemed transfer of an asset occurring on or after January 1, 2013; and
b) The tax basis of the transferred asset carries over from the transferor to the transferee (i.e., the taxpayer) for federal income tax purposes.
To make an asset basis adjustment, a taxpayer must add any remaining bonus depreciation deductions associated with the transferred asset to the basis of the transferred asset and depreciate the adjusted basis over the remaining life of the asset. The remaining life of the asset is the remaining years in the asset’s federal recovery period, as determined under section 168(c) of the Code. 29
In addition, upon disposition of the asset, adjusted gross income must be increased or decreased to account for any differences in the basis for State and federal income tax purposes.
For examples and additional information of bonus asset basis adjustments, please refer to the Individual Income Tax Bulletin, Section IV, and “Bonus Asset Basis” at:
http://www.dornc.com/taxes/bonus_asset.html.
D. Interest Income on Government Obligations (G.S. § 105-130.3, G.S. § 105-130.5)
1. North Carolina Obligations (17 NCAC 05C.0401)
Net interest income received by a corporation on obligations of the State of North Carolina and any of its cities, towns or counties is exempt from income taxes imposed by this State.
For examples of North Carolina obligations exempt from corporate income tax on interest income and gains, see www.dornc.com/taxes/individual/ncobligations.html.
2. Obligations of Other States (17 NCAC 05C.0402)
Net interest income earned by a corporation on its investments in obligations issued by states and their political subdivisions, other than the State of North Carolina, represents taxable income and is subject to this State’s income tax.
3. U.S. Obligations (17 NCAC 05C.0403)
Net interest income earned on bonds, notes or other obligations of the United States or its possessions is exempt from income taxation in this State so long as interest on obligations of the state of North Carolina and its political subdivisions is exempt from income taxes imposed by the United States.
For detailed information on U.S. obligations exempt from tax, see:
www.dornc.com/taxes/individual/usnc.html.
4. Sales or Exchanges (17 NCAC 05C.0404)
Gain or loss realized on the sale or other disposition of any type of obligation of the United States or its possessions, the State of North Carolina or its political subdivisions, any other state or its political subdivisions, or of any other government is a taxable transaction and must be included in the computation of a corporation’s State taxable income.
Gain or loss realized on the sale or other disposition of obligations of the State of North Carolina or its political subdivisions issued before July 1, 1995 is not included in taxable 30
income if North Carolina law under which the obligations were issued specifically exempts the gain or interest from taxation.
For examples of North Carolina obligations exempt from corporate income tax on interest income and gains, see:
www.dornc.com/taxes/individual/ncobligations.html.
5. Obligations of Federal National Mortgage Association (17 NCAC 05C.0405)
Interest income or other income realized on obligations of Federal National Mortgage Association is taxable income.
6. Mortgage Backed Certificate Guaranteed by Federal Agencies (17 NCAC 05C.0406)
Interest paid by the issuer to the holder of a mortgage backed certificate guaranteed by the Federal Government, corporations formed by the Federal Government and/or Federal Agencies is not income from an obligation of the United States Government and is taxable.
7. Repurchase Agreements (17 NCAC 05C.0407)
Income attributable to or received from repurchase agreements of U.S. government securities, an agreement to repurchase securities at an agreed price and date, is not considered income derived directly from federal obligations and is taxable income.
E. Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property (G.S. § 105-130.4, G.S. § 105-130.5, 17 NCAC 05C.0304)
1. Direct Expenses
All expenses directly connected with the production of income not subject to tax in this State are required to be used to compute the net amount of such untaxed income.
2. Interest Expense
When a corporation earns income which is not taxed by this State (see examples), and/or holds property that does or will produce untaxed income, and incurs interest expense, which is not specifically related to any particular income or property, it must attribute a portion of the interest expense to such untaxed income and property in determining taxable income reported to this State. The formula for computing the amount of interest expense to be attributed to untaxed income and property is as follows:
a. Assets
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i. Value on the tax return balance sheet of assets that produce or which would produce untaxed income. (When the equity method of accounting is used, the increase or decrease in value as result of such accounting may be excluded from this value.)
ii. Value of all assets on the tax return balance sheet. (Equity included in this value may be excluded and the reserve for depreciation reflected on the balance sheet may be restored to the asset value.)
iii. Determine the ratio or percentage of i to ii
b. Income
i. Gross Untaxed Income
ii. Total Gross Profits
iii. Determine the ratio or percentage of i to ii
c. Total of the ratios or percentages determined in a and b above.
d. Divide total of c by 2
e. Apply average percentage determined in d to the total interest expense on the return filed in this State.
Examples of untaxed income:
 Dividend income not taxed, including dividends excluded by section 243 of the Code and dividends classified as nonapportionable (G.S. §§ 105-130.4, 105-130.5(c)(3))
 Interest income classified as nonapportionable (G.S. § 105-130.4)
 Interest income earned on obligation of the United States and the State of North Carolina.
 Other nonapportionable income and/or exempt income
3. Expense Connected With Interest Income From United States Obligations
Under G.S. § 105-130.5(b)(1), interest income from obligations of the United States or its possessions is excludable from North Carolina taxable income to the extent such income is included in federal taxable income. Since federal taxable income is in effect a net income, expenses incurred in producing the exempt income must be determined and subtracted from the gross amount earned during a taxable period before the deduction is made in computing the state taxable income. The basis for requiring this adjustment to exempt income is based on federal case law. (First National Bank of Atlanta v. Bartow County Board of Tax Assessors, 470 U.S. 583, 84 L. Ed. 2d 535 (1985) and supported by an advisory opinion of the North Carolina Attorney General.)
In the computation of expenses related to income from United States obligations, the formula described above in Item 2 may be used with respect to interest expense.
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4. Dividends (G.S. §§ 105-130.5(b)(3a) and (c)(3))
For tax years beginning on or after January 1, 2016, expenses attributed to dividends not tax for North Carolina income tax purposes cannot exceed 15%.
5. Other Expenses Attributed to Nontaxable Income and to Nonapportionable Income and Property
In the determination of expenses other than interest expense attributed to untaxed income, the methodologies set forth in the Code for determining expenses related to foreign source income generally referred to as stewardship and supportive expenses may be used to determine the expenses allocated to untaxed income and property producing or which would produce untaxed income.
Alternatively, an income formula as outlined in Item 2 above may be used to determine the amount of supportive function expenses attributable to untaxed income. In determining “supportive function expenses”, direct expenses incurred exclusively in a specific identifiable taxable or nontaxable activity should be excluded before applying the attribution percentage to expenses. If direct expenses are determinable for a particular activity resulting in an accurate computation of the net income or loss from such activity, the values of this activity are removed from the two ratios when computing the attribution percentage.
F. Related Entity Interest Deduction Limitation (G.S. § 105-130.7B)
1. Preliminary Statement
For tax years beginning on or after January 1, 2016, a corporation may only deduct the amount of qualified interest expense from a related member, as defined in G.S. § 105-130.7A, unless an exception applies.
2. Qualified Interest Expense
Qualified interest expense is the greater of the amount of interest paid or accrued from a related member up to 15% of the taxpayer’s adjusted taxable income as computed without a deduction for related party interest unless an exception applies, or the taxpayer’s proportional share of interest. The 15% limitation does not apply to amounts that qualify for an exception under G.S. § 105-130.7B(4).
A taxpayer’s proportionate share of interest is
a. The amount paid or accrued directly to or through a related member to an ultimate payer, divided by
b. The total net interest expense of all related members paid or accrued directly through a related member to the same ultimate payer, multiplied by
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c. The interest amount paid or accrued by the ultimate payer to an unrelated party. Amounts distributed, paid, or accrued through a related member that is not treated as interest for North Carolina income tax purposes does not qualify.
The ultimate payer is the related member that receives or accrues interest directly or indirectly from other related members and pays or accrues interest to an unrelated entity.
3. Exceptions
The 15% limitation does not apply if
a. An income tax is imposed by North Carolina on the amount of interest income received by the related member;
b. An income or gross receipts tax is imposed by another state on the related member with respect to the interest income;
c. The related member is an entity organized under the laws of a foreign country that has a comprehensive tax treaty with the United States and taxes the interest income at a rate equal to or greater than provided under G.S. § 105-130.3; or
d. The related member is a bank. For the purposes of this section, a bank includes a bank holding company as defined in the Bank Holding Company Act of 1956; a bank, savings bank, savings and loan association, or trust company, as each is defined in G.S. §§ 53C, 54B, and 54C; or a subsidiary or affiliate of any of these entities.
G. Allocation and Apportionment Procedures (G.S. § 105-130.4)
1. Preliminary Statement
A corporation that is taxable both within and without North Carolina is required to allocate and apportion its entire net income or loss to North Carolina in accordance with the statutory formula under G.S. § 105-130.4.
No corporation is allowed to use any alternative formula or method of reporting its income to North Carolina except upon written order of the Secretary of Revenue. Any return in which any formula or method other than as prescribed by statute is used without the permission of the Secretary is not a lawful return.
2. Alternate Apportionment Formula (17 NCAC 05D.0107-.0115)
If a C corporation, S corporation, or limited liability company electing to be taxed as either a C or S corporation for federal income tax purposes, believes that the statutory apportionment formula subjects a greater portion of its income than is reasonably attributable to business or earnings in this State, it may make a written request with the Secretary of Revenue for permission to use an alternate apportionment formula. The request must set out the reasons for 34
the corporation’s belief and propose an alternative method. The corporation has the burden of proof for demonstrating why the statutory method subjects it to taxation on a greater proportion of income than is reasonable attributable to North Carolina.
The written request must be made with the Secretary not later than ninety (90) days after the regular or extended due date of the tax return. Taxpayers should address all correspondence in connection with such petitions to the Secretary of Revenue, Department of Revenue, PO Box 871, Raleigh, NC 27602-0871. The Secretary will schedule a conference to hear the corporation’s request. The Secretary and the Director of the Income Tax Division and/or their designee(s) will attend the conference. The taxpayer is not required to appear or be represented at the conference; however, an authorized representative may appear on behalf of, or in addition to, the taxpayer.
The Secretary must issue a written decision on a corporation’s request for an alternative apportionment method within sixty days from the date of the conference or sixty days after the date any requested additional information is provided. The decision can apply to no more than three years. A corporation may renew a request to use an alternative apportionment method by reapplying to the Secretary of Revenue. A corporation authorized to use an alternative formula may apportion its Net Worth base using the alternative method or the statutory method.
If the Secretary finds the statutory method does not fairly represent the corporation’s activities in the State, remedies include requiring separate accounting, inclusion or exclusion of one or more factors, or any other method that results in equitable apportionment and allocation of income. If the request is for both income and franchise tax, a separate determination will be made for each tax.
If the request is denied, the Secretary’s decision is final and is not subject to administrative or judicial review. A corporation may not use an alternative apportionment method except upon written order by the Secretary, and any return filed using a method other than the statutory method without the Secretary’s permission is not a lawful return.
3. Statutory Procedures for Reporting Net Income or Loss to North Carolina
a. Determine North Carolina Taxable Income
A corporation must determine its State net income or loss from its entire operations conducted everywhere during the income year in accordance with the instructions given in the subject “Computation of Net Income.” In computing such net income only contributions to donees outside North Carolina are deductible. Contributions to qualified North Carolina donees are deductible only from total income allocated to North Carolina, computed in Step h.
b. Determine Nonapportionable Income
A corporation must review its entire net income or loss as computed in Step a to determine whether any items of nonapportionable income, loss and expense qualify for direct allocation 35
to North Carolina and other states pursuant to G.S. § 105-130.4, subdivisions (d) through (h). Any expenses directly and/or indirectly related to an activity that produces nonapportionable income must be considered in the computation of nonapportionable income to be allocated. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property”.
c. Determine Apportionable Income
A corporation determines its apportionable income or loss by deducting all nonapportionable income or loss directly allocable to North Carolina and other states (computed in Step b) from its entire net income or loss (computed in Step a).
d. Compute Apportionment Factors
A corporation is required to determine and compute the apportionment factor applicable to its principal business operations conducted everywhere during the income year. When the income from specific property constitutes nonapportionable income, the value of such property and items of nonapportionable income, loss, and expense directly allocable to North Carolina and other states must be excluded in computing the apportionment factors.
e. Income Apportioned to North Carolina
A corporation determines the amount of its apportionable income or loss attributable to North Carolina by applying the factor computed in Step d to apportionable income or loss as computed in Step c.
f. Determine Nonapportionable Income Allocated to North Carolina
A corporation should review the total amount of nonapportionable income or loss as computed in Step b and list separately the amount of such income or loss directly allocable to North Carolina. This amount, added to the amount of apportionable income or loss apportioned to this State in Step e, represents the total amount of the corporation’s entire net income or loss that is subject to North Carolina tax.
g. Percentage Depletion Deduction Before Net Economic or State Net Loss Deduction
The amount of percentage depletion over cost depletion on North Carolina property must be deducted before claiming any net economic or state net loss carryover deduction.
h. Determine Income Before Contributions to North Carolina Donees
To determine total North Carolina income before the deduction for contributions to North Carolina donees, a corporation deducts the allowable portion of any net economic loss or State net loss for a prior year or years from the total income determined as described in Step g.
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i. Determine Net Taxable Income
Finally, a corporation arrives at its net taxable income in North Carolina by deducting contributions made to qualified North Carolina donees from the amount of total North Carolina income as computed in Step h.
H. Taxable in Another State (G.S. § 105-130.4)
1. Preliminary Statement (17 NCAC 05C.0601)
A taxpayer must have income from business activity taxable by this State and at least one other state to allocate and apportion income. Income from business activity includes apportionable or nonappportionable income. Thus, if a taxpayer has nonapportionable income taxable by one state and apportionable income taxable by another state, the taxpayer’s income must be allocated and apportioned in accordance with G.S. § 105-130.4. Where a corporation is not taxable in any other state on its apportionable income but is taxable in another state only because of nonapportionable income, all apportionable income is attributed to this State.
2. Definition of Taxpayer (17 NCAC 05C.0602)
The word “taxpayer” includes any corporation subject to the tax imposed by Article 4 of Chapter 105 of the General Statutes.
3. Taxable in Another State
A taxpayer is “taxable in another state” if it meets either one of two tests:
1.If by reason of business activity in another state the taxpayer is “subject to” a net income tax or any other tax measured by net income.
2.If another state has jurisdiction to subject the taxpayer to a net income tax based on business activity regardless of whether or not that state imposes such a tax on the taxpayer.
4. Taxable in Another State – When A Corporation is “Subject To” Tax (17 NCAC 05C.0604)
a. A taxpayer is “subject to” one of the taxes specified above only if it carries on business activities in another state. If the taxpayer voluntarily files and pays such tax when not required by the laws of that state or pays a minimal fee for qualification, organization or for the privilege of doing business in that state, but
 Does not actually engage in business activities in that state, or
 Does actually engage in some activity not sufficient for nexus and the minimum tax bears no relation to the corporation’s activities within such state, the taxpayer is not “subject to” tax within that state and is therefore not “taxable” in another state.
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Example: State A has a corporation franchise tax measured by net income for the privilege of doing business in that state. Corporation X files a return and pays the fifty dollars ($50) minimum tax, although it carries on no activities in State A. Corporation X is not “taxable” in State A.
b. The concept of taxability in another state is based upon the premise that every state in which the taxpayer is engaged in business activities may impose an income tax even though every state does not do so. In some states, other types of taxes may be imposed as a substitute for an income tax. Therefore, only those taxes which may be considered as basically revenue generating rather than regulatory measures shall be considered in determining whether the taxpayer is “taxable in another state.”
Example 1: State A requires all nonresident corporations which qualify or register in State A to pay to the Secretary of State an annual license fee or tax for the privilege of doing business in the state regardless of whether the privilege is in fact exercised. The amount paid is determined according to the total authorized capital stock of the corporation; the rates are progressively higher by bracketed amounts. The statute sets a minimum fee of fifty dollars ($50) and a maximum fee of five hundred dollars ($500). Failure to pay the tax bars a corporation from utilizing the state courts for enforcement of its rights. State A also imposes a corporation income tax. Nonresident Corporation X is qualified in State A and pays the required fee to the Secretary of State but does not carry on any activities in State A other than utilizing its courts. Corporation X is not “taxable” in State A.
Example 2: Same facts as Example 1 except that Corporation X has sufficient business activities in State A to establish nexus under the criteria followed in this state and is, therefore, subject to and pays the corporate income tax. Corporation X is “taxable” in State A.
Example 3: State B requires all nonresident corporations qualified or registered in State B to pay to the Secretary of State an annual permit fee or tax for doing business in the state. The base of the fee or tax is the sum of (1) outstanding capital stock, and (2) surplus and undivided profits. The fee or tax base attributable to State B is determined by a three-factor apportionment formula. Nonresident Corporation X, which operates a plant in State B, pays the required fee or tax to the Secretary of State. Corporation X is “taxable” in State B because of its business activities there.
Example 4: State C has a corporation franchise tax measured by net income for the privilege of doing business in that state. Corporation X files a return based upon its business activities in the state but the amount of computed liability is less than the minimum tax. Corporation X pays the minimum tax. Corporation X is “taxable” in State C.
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5. Taxable in Another State – When a State has Jurisdiction to Subject a Taxpayer to a Net Income Tax (17 NCAC 05C.0605)
The second test in Example 3 above applies if the taxpayer’s business activities are sufficient to give the state jurisdiction to impose a net income tax under the Constitution and statutes of the United States. Jurisdiction to tax is not present where the state is prohibited from imposing the tax by reason of the provisions of Public Law 86-272, 15 U.S.C.A. §§ 381-385. In the case of any “state”, as defined in G.S. § 105-130.4, other than a state of the United States or political subdivision of each state, the determination of whether such “state” has jurisdiction to subject the taxpayer to a net income tax shall be made as though the jurisdictional standards applicable to a state of the United States applied in that “state”. If jurisdiction is otherwise present, such “state” is not considered as without jurisdiction by reason of the provisions of a treaty between that state and the United States.
Example: Corporation X is actively engaged in manufacturing farm equipment in State A and in Foreign Country B. Both State A and Foreign Country B impose a net income tax but Foreign Country B exempts corporations engaged in manufacturing farm equipment. Corporation X is subject to the jurisdiction of State A and Foreign Country B.
I. Apportionable and Nonapportionable Income (G.S. § 105-130.4)
1. Division of Income – In General (17 NCAC 05C.0701)
When a taxpayer has income from sources within this State as well as income from sources outside this State, the division of income and the resulting determination of the portion of the taxpayer’s entire net income that is attributable to this State shall be determined pursuant to the allocation and apportionment provisions set forth in G.S. § 105-130.4. In such cases, the first step is to determine which portion of the taxpayer’s entire net income constitutes “apportionable income” and which portion constitutes “nonapportionable income”. The various items of nonappportionable income are then directly allocated to specific jurisdictions pursuant to the provisions of subsections (d) through (h) of G.S. § 105-130.4. The apportionable income of the taxpayer other than public utilities, excluded corporations, and qualified capital intensive corporations is divided between the jurisdictions in which the business is conducted pursuant to the property, payroll and sales apportionment factors set forth in subsections (j) though (1) of G.S. § 105-130.4. The sum of (1) the items of nonapportionable income directly allocated to this State, plus (2) the amount of apportionable income attributable to this State by the apportionment formula generally constitutes the amount of the taxpayer’s entire net income that is subject to tax under the income tax laws of this State.
The taxpayer shall classify income as apportionable or nonapportionable income on a consistent basis. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
The word “apportionment” generally refers to the division of net income between jurisdictions by the use of a formula containing apportionment factors, and the word “allocation” generally refers to the assignment of net income to a particular jurisdiction. 39
2. Apportionable and Nonapportionable Income Defined (G.S. § 105.130.4)
“Apportionable income” is defined as all income that is apportionable under the United States Constitution. For purposes of administration of G.S. § 105-130.4, all income of a taxpayer is apportionable income unless clearly classifiable as nonapportionable income under the law and regulations. Nonapportionable income means all income other than apportionable income.
3. Apportionable and Nonapportionable Income – Application of Definitions
The classification of income by the labels customarily given them, such as interest, rents, royalties, and capital gains, is of no aid in determining whether that income is apportionable or nonapportionable income. The gain or loss recognized on the sale of property, for example, may be apportionable income or nonapportionable income depending upon the relation to the taxpayer’s trade or business. In general, all income from transactions and activites that are dependent upon or contribute to the operations of a taxpayer is apportionable. Income from unrelated activities is “nonapportionable” income.
4. Proration of Deductions Related to Apportionable and Nonapportionable Income (17 NCAC 05C.0704)
Any allowable deduction that is applicable both to apportionable and nonapportionable income or to more than one “trade or business” of the taxpayer is prorated to those classes of income or trades or businesses in determining income subject to tax. The taxpayer must be consistent in the proration of such deductions in filing returns under these regulations. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property”.
J. Apportionment Factors (G.S. § 105-130.4, G.S. § 105-130.4(i))
1. General Business Corporations
Corporations engaged in multistate business activity, other than public utilities, excluded corporations, and qualified capital intensive corporations are required to apportion to this State all apportionable income by using a four-factor formula. For tax years prior to those beginning on or after January 1, 2016, the apportionment formula consists of the sum of the property factor, the payroll factor and twice the sales factor divided by four. If the sales factor does not exist, the denominator is the number of existing factors. If a property or payroll factor does not exist, the denominator is the number of existing factors plus one. The only time a factor does not exist is when there is no denominator. When there is a denominator for a particular factor, but no numerator, the factor is zero and becomes part of the apportionment factor.
For tax years beginning on or after January 1, 2016, the apportionment factor will be calculated by adding the property factor, the payroll factor, and sales factor times three and dividing the result by five.
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For tax years beginning on or after January 1, 2017, the apportionment factor will be calculated by adding the property factor, the payroll factor, and sales factor times four and dividing the result by six.
For tax years beginning on or after January 1, 2018, all income will be apportioned using only the sales factor.
a. Property Factor (G.S. § 105-130.4) (This section is repealed effective for tax years beginning on or after January 1, 2018)
i. Property Factor – In General (17 NCAC 05C.0801)
The property factor includes all real and tangible personal property owned or rented and used during the income year to produce apportionable income. The term “real and tangible personal property” includes land, buildings, machinery, stocks of goods, equipment and other real and tangible personal property used in connection with the production of apportionable income but does not include coin or currency. See definition of “apportionable income”.
Property used in connection with the production of nonapportionable income that is allocated in accordance with subsections (d) through (h) of G.S. § 105-130.4 is excluded from the factor.
Property used in connection with the production of both apportionable and nonapportionable income is included in the factor only to the extent the property was used in connection with the production of apportionable income. The method of determining that portion of the value to be included in the factor will depend upon the facts of each case.
The property factor includes the average value of property includible in the factor.
ii. Property Factor – Property Used for the Production of Apportionable Income (17 NCAC 05C.0802)
Property is included in the property factor if it is actually used during the income year for the production of apportionable income. Property held as reserves or standby facilities or property held as a reserve source of materials shall be included in the factor. For example, a plant temporarily idle or raw material reserves not currently being processed are includible in the factor. Property that is permanently idle or idle for the entire taxable year generally is not included in the factor computation. Property or equipment under construction during the income year (except inventoriable goods in process) is excluded from the factor until such property is actually used for the production of apportionable income. If the property is partially used for the production of apportionable income while under construction, the value of the property to the extent used is included in the property factor.
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iii. Property Factor – Consistency in Reporting (17 NCAC 05C.0803)
The taxpayer must be consistent in the valuation of property and in excluding or including property in the property factor in filing returns with this State. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
iv. Property Factor – Numerator (17 NCAC 05C.0804)
The numerator of the property factor includes the average value of the taxpayer’s real and tangible personal property owned or rented and used in this State during the income year for the production of apportionable income.
Property in transit between locations of the taxpayer to which it belongs is considered to be at the destination for purposes of the property factor. Property in transit between a buyer and seller which is included by a taxpayer in the denominator of its property factor in accordance with its regular accounting practices is included in the numerator according to the state of destination.
The value of mobile or movable property such as construction equipment, trucks or leased electronic equipment which is located within and without this State during the income year is determined for purposes of the numerator of the factor on the basis of total time within the State during the income year. An automobile assigned to a traveling employee is included in the numerator of the factor of the state to which the employee’s compensation is assigned under the payroll factor or in the numerator of the state in which the automobile is licensed.
v. Property Factor – Valuation of Owned Property (17 NCAC 05C.0805)
Property owned by the taxpayer is valued at its original cost. “Original cost” of property which has a basis other than zero for federal income tax purposes equals the basis of the property for federal income tax purposes at the time of acquisition by the taxpayer and adjusted by subsequent capital additions or improvements thereto and partial disposition thereof, by reason of sale, exchange, abandonment, or any other type of disposition.
“Original cost” of property that has a zero basis for federal income tax purposes shall equal the taxpayer’s actual cost of the property at the time of acquisition. If the actual cost is unknown, the original cost shall equal the fair market value of the property, or, at the option of the taxpayer, eight times the net annual rental rate as described in G.S. § 105-130.4(j)(2). The valuation method chosen by the taxpayer must be used consistently thereafter.
Example 1: Taxpayer acquired a factory building in this State at a cost of five hundred thousand dollars ($500,000) and years later, expended one hundred thousand dollars ($100,000) for major remodeling of the building. Taxpayer files its return on the calendar year basis and claims a depreciation deduction in the amount of twenty-two thousand 42
dollars ($22,000) on the building. The value of the building includible in the numerator and denominator for the property factor is six hundred thousand dollars ($600,000), as the depreciation deduction is not taken into account in determining the value of the building for purposes of the factor.
Example 2: X corporation merges into Y corporation in a nontaxable reorganization under the Internal Revenue Code. At the time of the merger, X corporation owns a factory which X built years earlier at a cost of one million dollars ($1,000,000). X has been depreciating the factory at the rate of two percent (2%) per year, and its basis in X’s hands at the time of the merger is six hundred thousand dollars ($600,000). Since the property is acquired by Y in a transaction in which, under the Internal Revenue Code, the basis in Y’s hands is the same as the basis in X’s, Y includes the property in Y’s property factor at X’s original cost, without adjustment for depreciation, i.e., one million dollars ($1,000,000).
Example 3: Corporation Y acquires the assets of corporation X in a liquidation by which Y is entitled to use its stock cost as the basis of the X assets under the Internal Revenue Code. Under these circumstances, Y’s cost of the assets is the purchase price of the X stock, prorated over the X assets.
Example 4: Corporation X was deeded from local government a potential manufacturing facility (cost unknown) with a market value of one million dollars ($1,000,000) as an incentive for locating in the State. Since the property would have a zero basis for federal income tax purposes under section 118(a), Corporation X includes the one million dollars ($1,000,000) fair market value of the property in the computation of its property factor, or at X’s option may include eight times the net annual rental rate of the property.
Inventory of stock of goods is included in the factor in accordance with the valuation method used for federal income tax purposes, except when inventory is valued by use of the LIFO method, actual cost of the FIFO valuation method must be used.
Property acquired by gift or inheritance is included in the factor at its basis for determining depreciation for federal income tax purposes.
vi. Property Factor – Rented Property
Property rented by the taxpayer is valued at eight times the net annual rent paid during the current income year. Net annual rent is the total annual rent paid by the taxpayer less amounts received from subrentals. However, subrentals are not deducted when they constitute apportionable income. Rental values so determined are included in the numerator and denominator and are averaged by including such amounts at the beginning and at the end of the income year.
Example 1: The taxpayer receives subrents from a bakery concession in a food market operated by the taxpayer. The subrents are apportionable income and are not deducted from rent paid by the taxpayer for the food market.
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Example 2: The taxpayer rents a twenty-story office building and uses the lower two stories for its general corporation headquarters. The remaining eighteen (18) floors are subleased to others. The subrents are nonapportionable income and are to be deducted from the rent paid by the taxpayer.
“Annual rent” is the actual sum of money or other consideration payable, directly or indirectly, by the taxpayer or for its benefit for the use of the property and includes:
 Any amount payable for the use of real or tangible personal property, or any part thereof, whether designated as a fixed sum of money or as a percentage of sales, profits or otherwise.
Example: A taxpayer, pursuant to the terms of a lease, pays a lessor one thousand dollars ($1,000) per month as a base rental and at the end of the year pays the lessor one percent of its gross sales of four hundred thousand dollars ($400,000). The annual rent is sixteen thousand dollars ($16,000) (twelve thousand dollars ($12,000) plus one percent (1%) of four hundred thousand dollars ($400,000) or four thousand dollars ($4,000)).
 Any amount payable as additional rent or in lieu of rents, such as interest, taxes, insurance, repairs or any other items which are required to be paid by the terms of the lease or other arrangement, and does not include amounts paid as service charges, such as utilities, janitorial services, etc. If a payment includes rent and other charges unsegregated, the amount of rent is determined by consideration of the relative values of the rent and the other items.
Example 1: A taxpayer, pursuant to the terms of a lease, pays the lessor twelve thousand dollars ($12,000) a year rent plus taxes in the amount of two thousand dollars ($2,000) and interest on a mortgage in the amount of one thousand dollars ($1,000). The annual rent is fifteen thousand dollars ($15,000).
Example 2: A taxpayer stores part of its inventory in a public warehouse. The total charge for the year was one thousand dollars ($1,000) of which seven hundred dollars ($700) was for the use of storage space and three hundred dollars ($300) for inventory, insurance, handling and shipping charges and C.O.D. collections. The annual rent is seven hundred dollars ($700).
“Annual rent” does not include incidental day-to-day expenses such as hotel and motel accommodations, daily rental of automobiles, etc.
Leasehold improvements shall, for the purposes of the property factor, be treated as property owned by the taxpayer regardless of whether the taxpayer is entitled to remove the improvements or the improvements revert to the lessor upon expiration of the lease. Hence, the original cost of leasehold improvements is included in the factor.
vii. Property Factor – Averaging Property Values
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As a general rule the average value of property owned by the taxpayer is determined by averaging the values at the beginning and ending of the income year. However, the Secretary may require averaging by monthly or other periodic values if such method of averaging is required to properly reflect the average value of the taxpayer’s property for the income year.
Averaging by monthly or other periodic values will generally be applied if substantial fluctuations in the values of the property exist during the income year or where property is acquired after the beginning of the income year or disposed of before the end of the income year.
b. Payroll Factor (G.S. § 105-130.4) (This section is repealed effective for tax years beginning on or after January 1, 2018)
i. Payroll Factor – In General
The payroll factor includes the total amount paid by the taxpayer for compensation in connection with earning apportionable income during the income year.
ii. Payroll Accounting Method (17 NCAC 05C.0902)
The total amount “paid” to employees is determined upon the basis of the taxpayer’s accounting method. If the taxpayer has adopted the accrual method of accounting, all compensation properly accrued shall be deemed to have been paid. Notwithstanding the taxpayer’s method of accounting, at the election of the taxpayer, compensation paid to employees may be included in the payroll factor by use of the cash method if the taxpayer is required to report such compensation under such method for unemployment compensation purposes.
The taxpayer must be consistent in the treatment of compensation paid in filing returns with this State. In the event the taxpayer is not consistent in its reporting it must disclose in its return to this State the nature and extent of the inconsistency.
iii. The Term “Compensation” (17 NCAC 05C.0903)
Compensation means wages, salaries, commissions and any other form of remuneration paid to employees for personal services. Payments made to an independent contractor or any other person not properly classified as an employee is excluded. Only amounts paid directly to employees are included in the payroll factor. Amounts considered paid directly include the value of board, rent, housing, lodging and other benefits or services furnished to employees by the taxpayer in return for personal services provided that such amounts constitute income to the recipient under the Internal Revenue Code. In the case of employees not subject to the Internal Revenue Code, e.g., those employed in foreign countries, the determination of whether such benefits or services would constitute income to the employees is as though such employees were subject to the Internal Revenue Code.
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iv. The Term “Employee”
Employee means (1) any officer of a corporation, or (2) any individual who, under the usual common-law rules applicable in determining the employer-employee relationship, has the status of an employee. Generally, a person will be considered to be an employee if he is included by the taxpayer as an employee for purposes of the payroll taxes imposed by the Federal Insurance Contributions Act; except that, since certain individuals are included within the term “employees” in the Federal Insurance Contributions Act who would not be employees under the usual common-law rules, it may be established that a person who is included as an employee for purposes of the Federal Insurance Contributions Act is not an employee for purposes of this regulation.
v. Payroll Factor Includes Only Apportionable Income Compensation and Excludes Compensation Paid to General Executive Officers
The payroll factor includes only compensation that is attributable to income subject to apportionment. The compensation of any employee whose activities are connected primarily with nonapportionable income is excluded from the factor. All compensation paid to general executive officers is excluded in computing the payroll factor. General executive officers include the chairman of the board, president, vice-presidents, secretary, treasurer, comptroller and any other office serving in similar capacities.
Example 1: The taxpayer uses some of its employees in the construction of a storage building that, upon completion, is used for the production of apportionable income. The wages paid to those employees are treated as a capital expenditure by the taxpayer. The amount of such wages is included in the payroll factor.
Example 2: The taxpayer owns various securities from which nonapportionable income is derived. The management of the taxpayer’s investment portfolio is the only duty of Mr. X, an employee. The salary paid to Mr. X is excluded from the payroll factor.
vi. Denominator of Payroll Factor (17 NCAC 05C.0906)
Except as provided above, the denominator of the payroll factor is the total compensation paid everywhere during the income year. Accordingly, compensation paid to employees whose services are performed entirely in a state where the taxpayer is exempt from taxation, for example, by Public Law 86-272, is included in the denominator of the payroll factor.
Example: A taxpayer has employees in its state of legal domicile (State A) and is taxable in State B. In addition the taxpayer has other employees whose services are performed entirely in State C where the taxpayer is exempt from taxation by Public Law 86-272. As to these latter employees, the compensation will be assigned to State C where their services 46
are performed (i.e., included in the denominator only of the payroll factor) even though the taxpayer is not taxable in State C.
vii. Numerator of Payroll Factor (17 NCAC 05C.0907)
Except as provided above, the numerator of the payroll factor is the total amount paid in this State during the tax period by the taxpayer for compensation. If compensation paid to employees is included in the payroll factor by use of the cash method of accounting or if the taxpayer is required to report such compensation under such method for unemployment compensation purposes, it shall be presumed that the total wages reported by the taxpayer to this State for unemployment compensation purposes constitutes compensation paid in this State except for compensation excluded under Item v above. The presumption may be overcome by satisfactory evidence that an employee’s compensation is not properly reportable to this State for unemployment compensation purposes.
Compensation is paid in this State if any one of the following tests, applied consecutively, is met:
1. The employee’s service is performed entirely within the State.
2. The employee’s service is performed both within and without the State, but the service performed without the State is incidental to the employee’s service within the State. The word “incidental” means any service which is temporary or transitory in nature, or which is rendered in connection with an isolated transaction.
3. If the employee’s services are performed both within and without this State, the employee’s compensation will be attributed to this State if:
 The employee’s base of operations is in this State; or
 There is no base of operations in any state in which some part of the service is performed, but the place from which the service is directed or controlled is in this State; or
 The base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the employee’s residence is in this State.
The words “base of operations” means the place of more or less permanent nature from which the employee starts his work and to which he customarily returns in order to receive instructions from the taxpayer or communications from his customers or other persons, or to replenish stock or other materials, repair equipment, or perform any other functions necessary to the exercise of his trade or profession at some other point or points.
The words “place from which the service is directed or controlled” refer to the place from which the power to direct or control is exercised by the taxpayer.
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viii. Corporations Utilizing Common Paymaster (17 NCAC 05C.0908)
A parent corporation or any corporation serving as common paymaster for payroll purposes shall eliminate from the numerator and denominator of its payroll factor computation the amounts paid on behalf of controlled members for which it has charged such member the exact cost and which does not meet the definition of compensation insofar as the common paymaster is concerned. The numerator and denominator of the payroll factor shall be determined in accordance with applicable statute after elimination of the described amounts.
A subsidiary or otherwise controlled corporation which is a member of and/or participant in a common paymaster plan for payroll purposes, shall include in its numerator and denominator of the payroll factor computation amounts paid to its parent corporation or to another corporation of the controlled group as reimbursement in whatever form and by whatever label for employees’ compensation as defined. The amounts paid by the subsidiary or controlled corporation includable in the numerator and the denominator of the payroll factor shall be determined in accordance with applicable statute.
c. Sales Factor (G.S. § 105-130.4)
i. Sales Factor – Sales Made in General Business Operations (17 NCAC 05C.1001)
G.S. § 105-130.4(a)(7) defines “sales” to mean all gross receipts of the taxpayer except receipts from the “casual sale” of property, receipts allocated under subsections (c) through (h) of G.S. § 105-130.4, receipts exempt from taxation, and the portion of receipts realized from the sale or maturity of securities or other obligations that represents a return of principal. For taxable years beginning January 1, 2016, sales also excludes the portion of receipts from financial swaps and other similar financial derivatives representing the notional principal amount that generates cash flow traded in the swap agreement, and dividends subtracted under G.S. § 105-130.5(b)(3a) and (3b), and dividends excluded from federal tax.
Thus, for the purposes of the sales factor, the term “sales” means generally all gross receipts derived by a taxpayer from transactions and activities in the course of its regular trade or business operations which produce apportionable income within the meaning of G.S. § 105-130.4(a)(1).
A “casual sale” of property means the sale of any property that was not purchased, produced, or acquired primarily for sale in the corporation’s regular trade or business.
In the case of a taxpayer whose business activity consists of manufacturing and selling or purchasing and reselling goods or products, “sales” includes all gross receipts from the sales of such goods or products (or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year) held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business. Gross receipts means gross sales, less returns and allowances, and includes all interest 48
income, service charges, carrying charges or time-price differential charges incidental to such sales. Federal and state excise taxes (including sales taxes) shall be included as part of such receipts if such taxes are passed on to the buyer or included as part of the selling price of the product.
ii. Sales Factor – Sales Incidental To General Business Operations (17 NCAC 05C.1002)
As a general rule, “sales” also includes gross receipts derived by a taxpayer from business transactions or activities which are incidental to its principal business activity and which are includable in apportionable income. However, substantial amounts of gross receipts arising from an incidental or occasional sale of a fixed asset used in connection with the taxpayer’s regular trade or business will be excluded from the sales factor since such sales constitute a “casual sale” of property and the inclusion of such gross receipts will not fairly apportion to this State the income derived by the taxpayer from its business activity in this State. For example, gross receipts from the sale of a factory or plant will be excluded from the sales factor but the gain or loss on the sale will be included in apportionable income.
Likewise, the “proceeds” from “rollover” of working capital invested in certificates of deposits, money market accounts, etc., on a short-term temporary basis are not considered gross receipts for sales factor purposes. The earnings of such investments whether labeled as gains or interest will be the only amounts includable in the sales factor.
In including or excluding gross receipts, the taxpayer shall be consistent in the treatment of such gross receipts in filing returns with this State. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
iii. Sales Factor – Sales Made In Other Types of Business Activity (17 NCAC 05C.1003)
As applied to a taxpayer engaged in business activity other than the manufacturing and selling or purchasing and reselling of property, “sales” includes the gross receipts as defined in this subject.
If the business activity consists of providing services, such as the operation of an advertising agency, or the performance of equipment service contracts, research and development contracts, “sales” includes the gross receipts from the performance of such services including fees, commissions, and similar items including prepaid amounts for these services.
In the case of cost plus fixed fee contracts, such as the operation of a government-owned plant for a fee, gross receipts includes the entire reimbursed cost, plus the fee.
If the business activity is the renting of real or tangible personal property, “sales” includes the gross receipts from the rental, lease, or licensing the use of the property. 49
If the business activity is the sale, assignment, or licensing of intangible personal property such as patents and copyrights, “sales” includes the gross receipts therefrom.
iv. Sales Factor – Numerator (17 NCAC 05C.1004)
The numerator of the sales factor will include the gross receipts from sales which are attributable to this State, and includes all interest income, service charges, carrying charges, or time-price differential charges incidental to such sales regardless of the place where the accounting records are maintained or the location of the contract or other evidence of indebtedness.
Where a taxpayer is not taxable in another state on its apportionable income but is taxable in another state only because of nonapportionable income, all sales shall be attributable to this State.
v. Sales Factor – What Sales of Tangible Personal Property Are In This State (17 NCAC 05C.1005)
Gross receipts from the sales of tangible personal property are in this State if the property is delivered or shipped to a purchaser within this State regardless of the f.o.b. point or other conditions of sale.
Property shall be deemed to be delivered or shipped to a purchaser within this State if the recipient is located in this State, even though the property is ordered from outside this State.
Example: The taxpayer, with inventory in State A, sold one hundred thousand dollars ($100,000) of its products to a purchaser having branch stores in several states including this State. The order for the purchase was placed by the purchaser’s central purchasing department located in State B. Twenty-five thousand dollars ($25,000) of the purchase order was shipped directly to purchaser’s branch store in this State. The branch store in this State is the “purchaser within this State” with respect to twenty-five thousand dollars ($25,000) of the taxpayer’s sales.
Property is delivered or shipped to a purchaser within this State if the shipment terminates in this State, even though the property is subsequently transferred by the purchaser to another state.
Example: The taxpayer makes a sale to a purchaser who maintains a central warehouse in this State at which all merchandise purchased is received. The purchaser reships all the goods to its branch stores in other states for sale.
All of the taxpayer’s products shipped to the purchaser’s warehouse in this State are property “delivered or shipped to a purchaser within this State.”
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The term “purchaser within this State” shall include the ultimate recipient of the property if the taxpayer in this State, at the designation of the purchaser, delivers to or has the property shipped to the ultimate recipient within this State.
Example: A taxpayer in this State sold merchandise to a purchaser in State A. Taxpayer directed the manufacturer or supplier of the merchandise in State B to ship the merchandise to the purchaser’s customer in this State pursuant to the purchaser’s instructions. The sale by the taxpayer is “in this State.”
When property being shipped by a seller from the state of origin to a consignee in another state is diverted while in route to a purchaser in this State, the sales are in this State.
Example: The taxpayer, a produce grower in State A, begins shipment of perishable produce to the purchaser’s place of business in State B. While in route the produce is diverted to the purchaser’s place of business in this State where the taxpayer is subject to tax. The sale by the taxpayer is attributed to this State.
vi. Sales Factor – Sales To United States Government (17 NCAC 05C.1006)
Gross receipts from the sales of tangible personal property to the United States Government are in this State if the property is shipped to or received or accepted by the United States Government in this State. For the purposes of this regulation, only sales for which the United States Government makes direct payment to the seller pursuant to the terms of its contract constitute sales to the United States Government. Thus, as a general rule, sales by a subcontractor to the prime contractor, the party to the contract with the United States Government, do not constitute sales to the United States Government.
Example 1: A taxpayer contracts with General Services Administration to deliver X number of trucks which were paid for by the United States Government. The United States Government is the purchaser.
Example 2: The taxpayer is a subcontractor to a prime contractor with the National Aeronautics and Space Administration and contracts to build a component of a rocket for one million dollars ($1,000,000). The sale of the subcontractor to the prime contractor is not a sale to the United States Government.
When the United States Government is the purchaser of property which remains in the possession of the taxpayer in this State for further processing under another contract, or for other reasons, “shipment” is deemed to be made at the time of acceptance by the United States Government.
vii. Sales Factor – Numerator – Other Receipts Constituting Apportionable Income
G.S. § 105-130.4(l)(3) contains provisions for including gross receipts from other business income transactions in the numerator of the sales factor. Under this subsection gross receipts are attributed to this State, if: 51
1. The receipts are from real or tangible property located in this State; or
2. The receipts are from intangible property and are received from sources in this State; or
3. The receipts are from services and the income producing activity that gave rise to the receipts is performed within this State.
The term “income producing activity” means the act or acts directly engaged in by the taxpayer, or by anyone acting on the taxpayer’s behalf, in the regular course of its trade or business for the ultimate purpose of obtaining gains or profits.
Except for receipts from the casual sale of property, as defined above, receipts described above from other transactions constituting apportionable income shall be attributed to this State as set forth below:
1. Gross receipts from the sale, lease, rental or other use of real property are in this State if the real property is located in this State.
2. Gross receipts from the sale of electricity if the location of the income producing activity is located in this State.
3. Gross receipts from the rental, lease, licensing the use of, or other use of tangible property shall be assigned to this State if the property is within this State during the entire period of rental, lease, license or other use. If the property is within and without this State during such period, gross receipts attributable to this State shall be based upon the ratio which the time the property was physically present or was used in this State bears to the total time or use of the property everywhere during such period.
4. Gross receipts from intangible personal property shall be attributed to this State if they are received from sources within this State.
Example 1: Royalties from trademarks are attributed to this State to the extent the royalties are used in this State.
Example 2: Royalties from patents, secret processes, or other similar intangible property are attributed to this State to the extent the patent, secret process, or other similar intangible property is employed in production, fabrication, manufacturing, processing, or other similar use in this State.
Example 3: Royalties from copyrights are attributable to this State to the extent that printing or other publication originates in this State.
Example 4: Dividends are attributable to this State if the payer’s commercial domicile is in thi

State of North Carolina
CORPORATE INCOME, FRANCHISE, AND INSURANCE TAX BULLETIN
Reflecting Changes Made in the 2016 Regular Session
of the North Carolina General Assembly
Issued by:
Corporate Tax Division
Tax Administration
North Carolina Department of Revenue
501 North Wilmington Street
Raleigh, North Carolina 27604
June 2017
2
PREFACE
The Corporate Income, Franchise, and Insurance Tax Bulletin was prepared for the purpose of presenting the administrative interpretation and application of North Carolina corporate income, franchise, and insurance premiums tax laws at the time of publication. This publication supplements information provided in the Administrative Rules but does not supersede the Administrative Rules. In addition, this bulletin does not cover all provisions of the law.
Taxpayers are cautioned that this publication is intended merely as a guide and that consideration must be given to all the facts and circumstances in applying this Bulletin to particular situations. Taxpayers using this publication should be aware that additional changes may result from legislative action, court decisions, and rules adopted or amended under the Administrative Procedure Act, Chapter 150B of the General Statutes. To the extent there is any change to a statute, administrative rule, or new case law subsequent to the date of this publication, the provisions in this bulletin may be superseded or voided. Unless otherwise noted, this Bulletin is intended to reflect changes made in the 2016 regular session of the North Carolina General Assembly.
Revised June 2017
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TABLE OF CONTENTS
I. FRANCHISE TAX
A. General Information ………………………………………………………………….. p. 5
B. Holding Companies …………………………………………………………………... p. 7
C. General Business Corporations ………………………………………………………. p. 8
D. Net Worth Base ………………………………………………………………………. p. 10
E. Multistate Corporations ………………………………………………………………. p. 11
F. Investment in Tangible Property in North Carolina Base ……………………………. p. 12
G. Appraised Valuation of Tangible Property Base ……………………………………... p. 13
H. Corporate Members of LLCs …………………………………………………………. p. 13
I. Change of Income Year ………………………………………………………………. p. 15
J. Corporations Conditionally or Partially Exempt ……………………………………... p. 17
II. CORPORATE INCOME TAX
A. Corporations Subject to Tax, Tax Rate and Allocation Requirements ……………….. p. 19
B. Tax Credits ……………………………………………………………………………. p. 22
C. Computation of Net Income ………………………………………………………….. p. 22
D. Interest Income on Government Obligations ………………………………………… p. 29
E. Attribution of Expenses to Nontaxable Income and to ………………………………. p. 30
Nonapportionable Income and Property
F. Related Entity Interest Deduction Limitation ………………………………………… p. 32
G. Allocation and Apportionment Procedures …………………………………………… p. 33
H. Taxable in Another State ……………………………………………………………… p. 36
I. Apportionable and Nonapportionable Income ………………………………………... p. 38
J. Apportionment Factors ………………………………………………………………... p. 39
K. Deduction of Contributions …………………………………………………………… p. 55
L. Rapid Amortization of Equipment Mandated by OSHA ……………………………... p. 57
M. Amortization of Bond Premiums ……………………………………………………... p. 57
N. Net Economic Loss Carry-Over ………………………………………………………. p. 59
O. State Net Loss Deduction ……………………………………………………………... p. 65
P. Secretary’s Authority to Adjust Net Income or Require a Combined Return ………… p. 68
Q. Partnership and the Corporate Partner ………………………………………………… p. 75
R. Filing of Returns and Payment of Taxes ……………………………………………… p. 76
S. Extension of Time for Filing Return ………………………………………………….. p. 79
T. Dissolutions and Withdrawals ………………………………………………………… p. 79
U. Suspensions and Reinstatements ……………………………………………………… p. 80
V. Exempt Corporations …………………………………………………………………. p. 81
W. Reporting Federal Changes …………………………………………………………… p. 85
X. Domestic International Sales Corporation ……………………………………………. p. 87
Y. S Corporations ………………………………………………………………………… p. 88
Z. Qualified Subchapter S Subsidiaries ………………………………………………….. p. 89 4
III. INSURANCE PREMIUMS TAX
A. General Information …………………………………………………………………... p. 91
B. Insurance Companies Subject to the Tax under G.S 105-228.5 ……………………… p. 91
C. Captive Insurance Companies Subject to the Tax under G.S. 105-228.4A …………... p. 91
D. Types of Tax and Charges ……………………………………………………………. p. 91
E. Tax Basis for Insurers taxed under G.S. 105-228.5 …………………………………... p. 92
F. Tax Basis for Captive Insurers taxed under G.S. 105.228.4A ………………………... p. 93
G. Tax Rates and Charges ………………………………………………………………... p. 93
H. Tax Rates and Charges for Captive Insurance Companies …………………………… p. 94
I. Retaliatory Provisions ………………………………………………………………… p. 94
J. Installment Payments …………………………………………………………………. p. 95
K. Due Dates ……………………………………………………………………………... p. 95
L. Electronic Funds Transfer (EFT) Requirement ……………………………………….. p. 95
M. Exempt Insurance Companies ………………………………………………………… p. 96
N. Tax Credits ……………………………………………………………………………. p. 96
O. Insurance Tax Administered by Department of Insurance …………………………… p. 97
P. No Additional Local Taxes …………………………………………………………… p. 97
Q. Exemption From Franchise or Corporate Income Tax ……………………………….. p. 97
R. Penalties ………………………………………………………………………………. p. 97
IV. TAX CREDITS
A. Overview ……………………………………………………………………………… p. 99
B. Tax Credits (Article 4) ………………………………………………………………... p. 99
C. Tax Incentives for New and Expanding Businesses ………………………………….. p. 113
D. Business & Energy Tax Credits ………………………………………………………. p. 114
E. Tax Incentives for Recycling Facilities (Article 3C) …………………………………. p. 119
F. Historic Rehabilitation Tax Credits (Article 3D) …………………………………….. p. 121
G. Historic Rehabilitation Tax Credits (Article 3L) ……………………………………... p. 124
H. Low-Income Housing Tax Credits (Article 3E) ………………………………………. p. 128
I. Research and Development Tax Credit (Article 3F) ………………………………….. p. 134
J. Credit for Mill Rehabilitation (Article 3H) …………………………………………… p. 137
K. Tax Credits for Growing Businesses (Article 3J) …………………………………….. p. 140
L. Tax Incentive for Railroad Intermodal Facility (Article 3K) …………………………………. P. 140 5
I. FRANCHISE TAX
(Article 3)
A. General Information (G.S. 105-114)
1. Scope and Nature
North Carolina levies a series of franchise taxes upon corporations, both domestic and foreign, and upon certain persons, limited liability companies (“LLCs”), and partnerships. The taxes levied in this subchapter are for the privilege of engaging in business or doing the act named. Specific sections of the law under which the various corporations and businesses are taxed are as follows:
G.S. § 105-114.1 Limited liability companies
G.S. § 105-120.2 Holding companies
G.S. § 105-122 General business corporations
G.S. § 105-125 Exempt corporations
The taxes levied upon corporations organized under the laws of North Carolina (domestic corporations) are for the corporate rights and privileges granted by their charters, and the enjoyment of corporate powers, rights, privileges and immunities under the laws of North Carolina.
The taxes levied upon corporations not organized under the laws of North Carolina (foreign corporations) are for the privilege of doing business in this State and for the benefit and protection they receive from the government and laws of this State.
A corporation, other than a holding company taxed under G.S. § 105-120.2, that is subject to one of the franchise taxes other than the general business franchise tax, is subject to the general business franchise tax to the extent it exceeds the other franchise tax.
2. Corporation Defined
For franchise tax purposes, the term “corporation” includes not only corporations in the usual meaning of the term, but also associations, joint stock companies, trusts and other organizations formed or operating for pecuniary gain which have capital stock represented by shares and privileges not possessed by individuals or partnerships. The term includes limited liability companies that elect to be taxed as corporations for federal income tax purposes.
3. S Corporations
S corporations are liable for franchise tax levied under Article 3 of the Revenue Laws.
4. Period Covered 6
Taxes levied under this Article are for the fiscal year of the State in which they become due, except that the taxes levied are for the income year of the corporation in which such taxes become due.
5. Inactive Corporations (17 NCAC 05B.0104)
A corporation that is inactive and without assets is subject to an annual minimum franchise tax of two hundred dollars ($200). Failure to file this return and pay the minimum tax will result in the suspension of the Articles of Incorporation or Certificate of Authority. Any corporation that intends to dissolve or withdraw through suspension for nonpayment of franchise tax should indicate its intention in writing to the Department.
6. Voluntary Dissolution or Withdrawal of Corporate Rights (G.S. § 105-127(d))
Corporations are not subject to franchise tax after the end of the income year in which articles of dissolution or withdrawal are voluntarily filed with the Secretary of State unless they engage in business activities not reasonably incidental to winding up their affairs. Therefore, no franchise tax is required with the income tax return filed for the year in which the application is filed or with any subsequent income tax returns that may be required in connection with winding up the affairs of the corporation.
Example 1: A calendar year corporation voluntarily files articles of dissolution or withdrawal during the calendar year 2017. Although its final income tax return will be filed on a franchise and income tax return, the franchise tax portion of the return need not be completed since the franchise tax applicable to calendar year 2017 was calculated on the 2016 tax return.
Example 2: A corporation using an income year ending April 30 voluntarily files articles of dissolution or withdrawal on May 19, 2017. Although its final income tax return will be filed on a franchise and income tax return, the franchise tax portion of the return need not be completed since the franchise tax applicable to the income year beginning May 1, 2017, was calculated on the tax return for the income year ended April 30, 2017.
A corporation is not entitled to a partial refund of franchise tax paid if the corporation files articles of dissolution or withdrawal during the year.
7. Payment of Franchise Taxes (G.S. § 105-122(a))
Franchise tax is due on the statutory filing date of the return, without regard to extensions.
8. Extension of Filing Date (17 NCAC 05B.0107)
A corporation subject to the franchise tax may obtain an extension of time for filing its franchise tax return by filing Form CD-419 within the time required pursuant to G.S. § 105-263. Form CD-419 is available at: http://www.dor.state.nc.us/downloads/corporate.html. 7
An extension of time for filing a franchise tax return does not extend the time for paying the tax due or the time when a penalty attaches for failure to pay the tax. For additional detailed information concerning the requirements for obtaining an extension of time for filing a corporate franchise and income tax return, see “Extension of Time for Filing Return” in Section II, Corporate Income Tax.
9. Tax Credit for Limited Liability Companies Subject to Franchise Tax (G.S. § 105-122.1)
LLCs that elect to be taxed as corporations for federal income tax purposes are allowed a tax credit against franchise tax equal to the difference between the annual report fee on corporations for filing paper annual reports under G.S. § 55-1-22(a)(23) and the annual report fee for limited liability companies under G.S. § 57D-1-22. The credit allowed may not exceed the franchise tax liability for the year reduced by the sum of all credits allowed, except payments of tax made by or on behalf of the taxpayer.
Example. An LLC that has elected to be taxed as a corporation computes its franchise tax due to be $500. Because the fee under for an LLC under G.S. § 57D-1-22 is $200, while the fee for a corporation filing a paper annual report under G.S. § 55-1-22(a)(23) is $25, a credit of $175 is allowed to the LLC against franchise tax.
B. Holding Companies (G.S. § 105-120.2)
1. Definition
A holding company is any corporation that receives more than eighty percent (80%) of its gross income during its taxable year from corporations in which it owns, directly or indirectly, more than fifty percent (50%) of the outstanding voting stock or voting capital interest. A corporation will also qualify for holding company status if it has no assets other than ownership interests in corporations in which it owns, directly or indirectly, more than 50% of the outstanding stock or voting capital interests.
If a holding company has an ownership interest in an LLC doing business in the State and the LLC is taxed as a corporation for federal income tax purposes, the holding company’s share of the income of the LLC is included in the denominator and, if the corporation owns more than fifty percent (50%) of the voting capital interest in the LLC, the holding company’s share of the income of the LLC is included in the numerator when computing the holding company test.
2. Basis for Taxation
The basis of the tax for a holding company is the same as for general business corporations. However, franchise tax payable by a qualified holding company on its net worth base is limited to one hundred and fifty thousand dollars ($150,000). Any corporation that qualifies as a holding company for franchise tax should fill in the circle next to Line 1 on Page 1 of the appropriate form, CD-405 or CD-401S. There is no limitation on the amount of franchise tax 8
payable where the tax produced by the investment in tangible property or appraised value of property exceed the tax produced by the net worth base.
C. General Business Corporations (G.S. § 105-122)
1. Basis for the Tax
For years beginning on or after January 1, 2017, the basis of the tax is the net worth of the taxpayer. The basis is the same for both domestic and foreign corporations. Corporations doing business both within and without North Carolina are required to apportion their net worth to North Carolina in accordance with a specified statutory apportionment formula. Regardless of the actual amount of net worth, the amount determined for purposes of this tax cannot be less than fifty-five percent (55%) of appraised ad valorem tax value of all the real and tangible property in North Carolina or less than the actual investment in tangible property in North Carolina.
2. Franchise Tax Calculation
Franchise tax is calculated on the largest of the following amounts:
 The net worth tax base
 Fifty-five percent (55%) of appraised ad valorem tax value of all real and tangible property in N. C.
 Actual investment in tangible property in North Carolina
3. Corporations Required to File
Unless specifically exempt under G.S. § 105-125, all active and inactive domestic corporations, and all foreign corporations with a Certificate of Authority to do business, or which are in fact doing business in this State, are subject to the annual franchise tax levied under G.S. § 105-122.
If an LLC is taxed as a corporation for federal tax purposes and a corporate member’s only connection to North Carolina is its ownership interest in the LLC, the corporate member(s) is not required to file a North Carolina corporate income and franchise tax return. The corporate member(s) is not required to file in this circumstance because the LLC reports its North Carolina income at the entity level and the apportionment attributes of the LLC do not flow through to the corporate member(s) as is the case when the LLC is disregarded or is treated as a partnership.
If an LLC is taxed as a corporation for federal tax purposes and a corporate member has activities in this State in addition to its ownership interest in the LLC, the corporate member(s) is required to file a corporate income and franchise tax return.
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4. Forms to be Used for Filing
The franchise tax is filed on Form CD-405 for C corporations and Form CD-401S for S corporations. These forms, along with other required corporate forms and instructions, are available from the Department’s web site at:
http://www.dor.state.nc.us/downloads/corporate.html.
5. Substitute Returns
Any substitute form must be approved by the Department of Revenue prior to its use. The guidelines for producing substitute forms are available on the Department’s website. If a taxpayer uses computer-generated returns, the software company is responsible for requesting and receiving an assigned barcode. The Department publishes a list of software developers that have received approval on the Department’s web site. Photocopies of the return are not acceptable. Returns that cannot be processed by our imaging and scanning equipment may be returned to the taxpayer with instructions to refile on an acceptable form.
6. Report and Payment Due
Corporations must file returns annually on or before the fifteenth day of the fourth month following the end of the income year. The return is filed as a part of a joint franchise and income tax return. Payment of the entire amount of franchise tax is required by the statutory due date of the return.
7. Tax Rate
The franchise tax rate is one dollar and fifty cents ($1.50) per one thousand dollars ($1,000) and is applied as set forth in the law. The minimum franchise tax is two hundred dollars ($200).
8. Franchise Tax Payable in Advance (G.S. § 105-114)
Franchise tax is payable in advance for the privilege of doing business in North Carolina or for the privilege of existing as a corporation in North Carolina.
Example: A corporation incorporates, domesticates or commences business in North Carolina on October 15, 2016. The corporation has selected a calendar year end. The first tax return due on April 15, 2017 will be a short period return covering the income tax period from October 15, 2016 to December 31, 2016. Franchise tax due on this return covers the ensuing calendar year through December 31, 2017 for the privilege of doing business in North Carolina or for the privilege of existing as a corporation in North Carolina.
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D. Net Worth Base (G.S. § 105-122(b)) – (Applicable to Tax Years Beginning On or After January 1, 2017 calculated on 2016 and after income tax returns)
1. Based on Year End Balance Sheet
Net worth is measured as of the end of the taxable year using generally accepted accounting principles (“GAAP”). If the corporation does not use GAAP in maintaining its books and records, then net worth is computed using the same accounting method used for federal income tax purposes, so as long as this method fairly represents the corporation’s net worth for franchise tax purposes.
2. Net Worth Defined
A corporation’s net worth is defined as the total assets of the corporation without regard to deductions for accumulated depreciation, depletion, or amortization minus total liabilities.
3. Adjustments to Net Worth
In determining net worth, the following adjustments are required:
(a) A deduction for accumulated depreciation, depletion, or amortization allowed for federal income tax purposes.
(b) A deduction for the cost of treasury stock.
(c) An addition for the amount of affiliated indebtedness owed to a parent, subsidiary, affiliate, or noncorporate entity if the corporation or affiliated group directly or indirectly owns 50% or more of the noncorporate entity, other than debt that is merely endorsed, guaranteed or otherwise supported by the corporation or affiliated group of corporations.
The addition for affiliated indebtedness may be reduced based on the ratio of the borrowed capital over the total assets of the creditor corporation. Borrowed capital does not include indebtedness incurred by a bank from a deposit evidenced by a certificate of deposit, passbook, cashier’s check, certified check, or similar document or record.
(d) A creditor corporation that is subject to franchise tax may deduct the amount of indebtedness owed to it by a parent, subsidiary, or affiliated corporation to the extent such indebtedness has been added by the debtor corporation in computing its franchise tax liability.
4. Other Definitions
In determining the net worth base, the following definitions apply:
(a) Affiliate – A corporation is an affiliate of another corporation if it is controlled directly or indirectly by the same parent corporation or same or associated financial interests through 11
stock ownership, interlocking directors, or by any other means whatsoever, whether the control is direct or through one or more subsidiary, affiliate, or controlled corporation.
(b) Affiliated Group – The same meaning as defined in G.S. § 105-114.1.
(c) Capital Interest – The right under the entity’s governing law to receive a percentage of the entity’s assets, after payments to creditors, if the entity were dissolved.
(d) Governing Law – The law under which the noncorporate entity was organized.
(e) Indebtedness – All loans, credits, goods, supplies, or other capital of whatsoever nature furnished by a parent, a subsidiary, an affiliate, or a noncorporate entity in which the corporation or an affiliated group of corporations owns directly or indirectly more than 50% of the capital interests of the noncorporate entity. Indebtedness does not include amount endorsed, guaranteed, or otherwise supported by one of the related corporations.
(f) Noncorporate entity – a person that is neither a human being nor a corporation.
(g) Parent – A corporation that directly or indirectly controls another corporation by stock ownership, interlocking directors, or by any other means whatsoever exercised by the same or associated financial interests, whether such control is direct or through one or more subsidiary, affiliated, or controlled corporations.
(h) Subsidiary – A corporation that is directly or indirectly subject to control by another corporation by stock ownership, interlocking directors, or by any other means whatsoever exercised by the same or associated financial interest, whether the control is direct or through one or more subsidiary, affiliated, or controlled corporations.
(i) Total assets – The sum of all cash, investments, furniture, fixtures, equipment, receivables, intangibles, and any other items of value owned by a person or a business entity.
E. Multistate Corporations (G.S. § 105-122(c1))
1. Apportionment Formula
Every corporation permitted to apportion its net income for income tax purposes under the provisions of G.S. § 105-130.4 must apportion its net worth for franchise tax purposes through use of the same fraction computed for apportionment of its apportionable income under G.S. § 105-130.4. A corporation that is subject to the general business franchise tax, but exempt from income tax, must apportion its net worth by using the apportionment factor it would have used had it been subject to the income tax. Adjustments in the method of apportionment authorized by the Secretary of Revenue for apportionment of net income do not apply automatically to apportionment of net worth. Unless the Secretary specifically authorizes a modified method of allocation for franchise tax purposes, the statutory formula must be used.
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2. Alternate Apportionment Formula
If any corporation believes that the statutory apportionment formula allocates more of its net worth to North Carolina than is reasonably attributable to its business in this State, it may make a written request to the Secretary of Revenue for permission to use an alternative formula which it believes is a better method to apportion its net worth to North Carolina.
The written request must be made with the Secretary not later than ninety (90) days after the regular or extended due date of the tax return. Taxpayers should address all correspondence in connection with such petitions to the Secretary of the Revenue.
The Secretary must issue a written decision on a corporation’s request for an alternative apportionment method. The decision can apply to no more than three years. If the request is denied, the Secretary’s decision is final and is not subject to administrative or judicial review. A corporation authorized to use an alternative formula may apportion its net worth base using the alternative method or the statutory method.
F. Investment in Tangible Property in North Carolina Base (G.S. § 105-122(d))
1. Basis For the Investment Base
This base includes the original purchase price plus additions and improvements and less reserve for depreciation permitted for income tax purposes of all tangible property, including real estate located in North Carolina at the end of the income year immediately preceding the due date of the return.
2. What is Includable in the Investment Base (17 NCAC 05B.1302)
Include all tangible assets located in North Carolina at original purchase price less reserve for depreciation permitted for income tax purposes. In addition to the types of property listed in the schedule, include all other tangible property owned such as supplies and tools. Typical items of tangible property would include: inventory (valued at actual cost or by method consistent with the actual flow of goods), consigned inventories to be included by consignor, machinery and equipment, furniture and fixtures, containers, tools and supplies, land, buildings, leasehold improvements, and all other tangible assets.
3. Treatment of Construction in Progress (17 NCAC 05B.1303)
Construction in progress is excluded from this base only if such property is not owned by the corporation filing the return.
4. Determination of Inclusion Based on Depreciation Deduction (17 NCAC 05B.1309)
When two or more corporations are in doubt as to which should include property, including leased property, in the investment in tangible property base, such property shall be included by the corporation allowed depreciation under the Federal Code. 13
5. Holding Company
There is no limitation on the franchise tax payable by a holding company on its investment in tangible property tax base.
G. Appraised Valuation of Tangible Property Base (G.S. § 105-122(d), 17 NCAC 05B.1406)
Tangible property values for this base are computed on fifty-five percent (55%) of the appraised value of all property listed for county ad valorem tax in North Carolina as of January 1 of the calendar year next preceding the due date of the return.
Note: Also included in the appraised value of property for county ad valorem tax is the appraised value of all vehicles for which the county tax assessor has issued a billing during the income year.
There is no limitation on the franchise tax payable by a holding company on its appraised valuation of property tax base.
H. Corporate Members of LLCs (G.S. § 105-114.1)
(This section does not apply to limited liability companies that are taxed as corporations, but does apply to noncorporate limited liability companies, i.e., limited liability companies that do not elect to be taxed as corporations under the Code.)
If a corporation or affiliated group of corporations owns, directly or constructively, more than fifty percent (50%) of the capital interests in an LLC, the corporation or group of corporations must include the same percentage of the LLC’s assets in its three franchise tax bases. In that case, the corporation’s investment in the LLC is not included in the calculation of the corporation’s capital stock, surplus and undivided profits base. The attribution to the three bases is equal to the same percentage of (1) the LLC’s capital stock, surplus and undivided profits, (2) fifty-five percent (55%) of the LLC’s appraised ad valorem tax value of property, and (3) the LLC’s actual investment in tangible property in this State.
Exception – if the total book value of the LLC’s assets never exceeds one hundred fifty thousand dollars ($150,000) during its taxable year, no attribution is required.
When a partnership, trust, LLC, or other entity is placed between a corporation and an LLC, ownership of the capital interests in an LLC is determined under the constructive ownership rules for partnerships, estates, and trusts in IRC § 318(a)(2)(A) and (B), modified as follows:
 The term “capital interest” is substituted for “stock” where that term appears in the referenced Code section.
 An LLC and any entity other than a partnership, estate or trust is treated as a partnership. 14
 The operating rule of section 318(a)(5) applies without regard to section 318(a)(5)(C).
Example: A partnership owns one hundred percent (100%) of the capital interests of an LLC. Corporation A is a fifty percent (50%) owner of the partnership. Corporation A constructively owns fifty percent (50%) of the capital interest in the LLC.
The members of an affiliated group must determine the percentage of the LLC’s assets to be included in each member’s franchise tax bases. If all members of the group are doing business in North Carolina, then the percentage of the LLC’s assets included by each member in its franchise tax bases is equal to the member’s percentage ownership in the LLC. If some of the members of the group are not doing business in North Carolina, then the percentage of the LLC’s assets owned by the group are allocated among the members that are doing business in North Carolina. The percentage attributed to each member doing business in North Carolina is determined by multiplying the percentage of the LLC owned by the entire group by a fraction. The numerator of the fraction is the percentage of the LLC owned by the member and the denominator is the total percentage of the LLC owned by all members doing business in North Carolina.
If the owner of the capital interests in an LLC is an affiliated group of corporations, the percentage to be included by each member that is doing business in this State is determined by multiplying the capital interests in the LLC owned by the affiliated group by a fraction. The numerator of the fraction is the capital interests of the LLC owned by the group member, and the denominator is the capital interests in the LLC owned by all group members that are doing business in this State.
Ownership of the capital interests in an LLC is determined under the constructive ownership rules for partnerships, estates, and trusts in IRC § 318(a)(2)(A) and (B), modified as follows:
 The term “capital interest” is substituted for “stock” where that term appears in the referenced Code section.
 A LLC and any entity other than a partnership, estate, or trust is treated as a partnership.
 The operating rule of section 318(a)(5) of the Code applies without regard to section 318(a)(5)(C).
Example: An affiliated group of corporations own one hundred percent (100%) of the capital interests in an LLC. The group consists of three corporations. Corporation A is doing business in North Carolina and owns fifty percent (50%) of the LLC. Corporation B is doing business in North Carolina and owns ten percent (10%) of the LLC. Corporation C is not doing business in North Carolina and owns forty percent (40%) of the LLC. The percentage of the LLC’s assets required to be included in Corporation A’s and Corporation B’s franchise tax bases is determined as follows:
Corporation A: 100% X 50%  (50% + 10%) = 83.33%
Corporation B: 100% X 10%  (50% + 10%) = 16.67%
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A corporation that is required to include a percentage of the LLC’s assets in its franchise tax computation may exclude its investment in the LLC from its computation of the net worth base.
Shifting assets back and forth between a corporation and an LLC to avoid franchise tax is prohibited. Ownership of the capital interests in an LLC is determined as of the last day of the LLC’s taxable year. The attribution of the LLC’s assets and the exclusion of the corporation’s investment in the LLC are made to the corporation’s next following franchise tax return. However, if the corporation and LLC engage in a pattern of transferring assets between them so that each did not own the assets on the last day of its taxable year, the ownership of the capital interest in the LLC must be determined as of the last day of the corporation’s taxable year.
Any taxpayer who, because of fraud with intent to evade tax, underpays the tax under this Article (G.S. 105 Article 3) is guilty of a Class H felony in accordance with G.S. 105-236(7). For additional information on the filing requirements for members of LLCs, see Item 5, Subsection J “Corporations Conditionally or Partially Exempt.”
I. Change of Income Year (105-122(e))
1. Computation of Tax (17 NCAC 05B.1501)
A change in income year automatically establishes a new franchise year. A joint franchise and income tax return is required for the short income period. Credit is permitted on such return against the franchise tax to the extent that the new franchise year overlaps the old year.
Example: A corporation changes its income year from a calendar year to one ending July 31. A combined franchise and income return is required for the short period January 1, 2017 through July 31, 2017 (seven (7) months). Franchise tax paid on the 2016 return applicable to the calendar year 2017 was $240. Franchise tax on the short period would be applicable to the year August 1, 2017 through July 31, 2018, and would be computed as follows:
Total tax due per return $268
Less credit for portion of prior year’s tax:
Total tax paid on 2006 return $240
Less amount applicable to short period (7/12 of $240) 140
Amount applicable beyond short period 100
Net franchise tax due on short period return $168
G.S. § 105-129.5(b) applies in computing the net franchise tax due for the short period. The statutorily computed tax is reduced by current installments and carryforwards of available tax credits, subject to the fifty percent (50%) limitation, before calculating the amount applicable to the short period and the amount applicable beyond the short period.
2. Computation of Tax When Merger is Involved (17 NCAC 05B.1502)
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Often when two corporations merge, a question arises concerning which corporation is liable for the franchise tax. If the merger is effective at any time after the close of the submerged corporation’s year-end, then the submerged corporation is liable for the tax. If the merger is effective at any time prior to the close of the submerged corporation’s year-end, then the surviving corporation is liable for the tax.
Since franchise tax is paid prospectively, a special computation is sometimes required to prevent a duplication of tax when two or more corporations with different income years merge or otherwise transfer the entire assets from one corporation to the other. The following example illustrates the conditions under which this occurs.
Example: ABC Corporation, whose income year ends July 31, merged into XYZ Corporation, whose income year is the calendar year. The merger occurred on October 31, 2016. ABC filed a combination franchise and income tax return for the year ended July 31, 2016 and paid franchise tax of six hundred dollars ($600) applicable to the ensuing year ending July 31, 2017. XYZ filed a combination franchise and income tax return for the calendar year 2016 and paid franchise tax of seven hundred dollars ($700) applicable to the ensuing calendar year 2017. The assets reflected in ABC’s tax base were also reflected in XYZ’s tax base since they had been transferred to XYZ in the merger, and therefore, were on its books as of the end of its income year, December 31, 2016. The year to which ABC’s payment applied overlapped the year to which XYZ’s payment applied by seven months (January 1, 2017 through July 31, 2017) and reflected a duplication of tax to that extent.
When the conditions illustrated in the above example exist, where, the acquiring corporation acquired the entire assets of the disposing corporation, the acquiring and disposing corporations had different income years, the date of merger or transfer was after the end of the disposing corporation’s income year next preceding such transfer but before the beginning of the surviving corporation’s income year next following such transfers, and the disposing corporation had paid franchise tax applicable to its income year in which the transfer occurred, the acquiring corporation may compute its franchise tax on its franchise and income tax return for the income year in which the transfer occurred as shown in the following example:
Franchise tax per surviving corporation’s return for
income year in which transfer occurred $700
Less: Franchise tax paid by submerged corporation per return
for income year immediately preceding transfer $600
Number of months between the ending dates
on the above returns 5
Number of months in year 12 x $600 = 250
Amount pertaining to overlapping months $350
Net franchise tax due $350 17
J. Corporations Conditionally or Partially Exempt (G.S. § 105-122, G.S. § 105-125)
1. Non-Profit Organizations
The following organizations and any other organization exempt from federal income tax under the Code are exempt from franchise tax if they are not organized for profit and if no profit inures to the benefit of any member, shareholder or other individual:
a. Fraternal societies, orders or associations. To qualify for income tax exemption, the organization must operate under the lodge system or for the exclusive benefit of members of a fraternity that is operating under the lodge system, and provide life, sick, accident or other benefits to the members or their dependents.
b. Corporations organized or trusts created for religious, charitable, scientific or educational purposes, including cemetery corporations and organizations for the prevention of cruelty to children and animals.
c. Business leagues, chambers of commerce, merchants associations and boards of trade.
d. Civic leagues or organizations operated exclusively for the promotion of civic welfare.
e. Clubs organized and operated exclusively for pleasure, recreation and other non-profit purposes.
f. Mutual hail, cyclone and fire insurance companies; mutual ditch, irrigation, canning and breeding associations; mutual or cooperative telephone companies; and like organizations of a purely local character which derive their entire income from assessments, dues or fees collected from members for the sole purpose of meeting expenses.
g. Farmer’s marketing associations operating as sales agents to market the products of members or other farmers, and to return to them the proceeds, less the necessary selling expenses, on the basis of the quantity of product furnished by them.
h. Pension, profit-sharing, stock bonus and annuity trusts established by employers for the purpose of distributing both the principal and income thereof exclusively to eligible employees or the beneficiaries of such employees. There must be no discrimination in favor of any particular employee. The interest of individual employees must be irrevocable and nonforfeitable to the extent of contributions by such employees. Exemption of a trust under the Federal income tax law is a prima facie basis for granting exemption from North Carolina franchise and income taxation.
i. Condominium associations, homeowner associations or cooperative housing corporations not organized for profit, the membership of which is limited to the owners or occupants of 18
residential units in the condominium, housing development, or cooperative housing corporation.
j. Cooperative or mutual associations formed under Section 54-124 of the General Statutes to conduct agricultural business on the mutual plan, and marketing associations formed under Section 54-129 of the General Statutes, are exempt from franchise tax.
2. Corporations Fully Exempt
These corporations qualify for the full franchise tax exemption:
 Insurance companies subject to the tax on gross premiums are exempt from the general business franchise tax.
 Telephone membership corporations organized under Chapter 117 of the General Statutes of North Carolina are exempt from the general business franchise tax. Electric membership corporations are, however, subject to franchise tax.
3. Regulated Investment Companies (RIC) and Real Estate Investment Trusts (REIT)
These organizations are required to pay franchise tax; however, in determining net worth they are allowed to deduct the aggregate market value of investments in the stock, bonds, debentures, or other securities or evidences of debt of other corporations, partnerships, individuals, municipalities, governmental agencies or governments. Captive REITs are not allowed this deduction. A captive REIT is a REIT whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are owned or controlled, at any time during the last half of the tax year, by a person that is subject to tax under this Part and is not a trust or another entity that qualifies as a real estate investment trust under section 856 of the Code or a listed Australian property.
4. Real Estate Mortgage Investment Conduits (REMIC)
These organizations are exempt from franchise tax to the extent the REMIC is exempt from income tax under the Code.
5. Limited Liability Company (LLC)
The “North Carolina Limited Liability Company Act” (Chapter 57C of the North Carolina General Statutes) permits the organization and operation of limited liability companies (LLC). An LLC is a business entity that combines the S corporation characteristic of limited liability with the flow-through features of a partnership. Noncorporate limited liability companies are not subject to the franchise tax. A noncorporate limited liability company is an LLC that does not elect to be taxed as a corporation under the Code.
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II. CORPORATE INCOME TAX
(Article 4 – Part 1)
A. Corporations Subject to Tax, Tax Rate and Allocation Requirements
(G.S. §§ 105-130.3 and 105-130.4)
1. Domestic and Foreign Corporations Required to File (17 NCAC 05C.0101)
All domestic corporations (those organized in North Carolina), and all foreign corporations (those organized outside North Carolina) with a certificate of authority to do business or doing business in North Carolina, are subject to income tax and are required to file annual income tax returns, except corporations specifically exempt from the tax under G.S. § 105-130.11, and S corporations exempt under G.S. § 105-131.1.
Because of a difference between the State income tax laws and the laws under the North Carolina Business Corporation Act, a foreign corporation operating in North Carolina may be liable for income tax even if not be required to obtain a certificate of authority to do business in North Carolina. For example, a Virginia corporation engaged in the general contracting business, which obtains a single, isolated job in North Carolina to be completed within six months, may not be required to obtain a certificate of authority to do business in this State under the Business Corporation Act but would be subject to income tax.
Note: A corporation organized in North Carolina or with a certificate of authority to do business in North Carolina must file an income tax return as a matter of record, even if the corporation was inactive or did not earn any net income in the tax year.
2. “Doing Business” Defined (17 NCAC 05C.0102)
For income tax purposes, the term “doing business” means the operation of any business enterprise or activity in North Carolina for economic gain, including, but not limited to, the following:
a. The maintenance of an office or other place of business in North Carolina;
b. The maintenance in North Carolina of an inventory of merchandise or material for sale, distribution or manufacture, regardless of whether kept on the premises of the taxpayer or in a public or rented warehouse;
c. The selling or distributing of merchandise to customers in North Carolina directly from a company-owned or operated vehicle when title to the merchandise is transferred from the seller or distributor to the customer at the time of the sale or distribution;
d. The rendering of a service to clients or customers in North Carolina by agents or employees of a foreign corporation; or 20
e. The owning, renting, or operating of business or income producing property in North Carolina including, but not limited to, the following:
 Realty;
 Tangible personal property;
 Trademarks, trade names, franchise rights, computer programs, copyrights, patented processes, licenses.
Corporations who are partners in a partnership or joint venture operating in North Carolina are considered to be “doing business” in the State.
“Doing business” by an interstate motor carrier is defined as the performance of any of the following business activities in North Carolina:
 The maintenance of an office in the State;
 The operation of a terminal or other place of business in the State;
 Having an employee working out of the office or terminal of another company;
 Dropping off or gathering up shipments in the State.
3. Corporations Operating in Interstate Commerce (17 NCAC 05C.0103)
The fact that a foreign corporation’s activities or operations in North Carolina are a part of its overall interstate business does not exempt the corporation from income tax liability. A corporation doing business in North Carolina as outlined above is subject to income tax even if its only operations in this State are a part of its interstate business. A foreign corporation not domesticated in North Carolina whose only activity in this State is the solicitation of sales of tangible personal property by either resident or nonresident salesmen is not required to file income tax returns under the Department’s current policy. However, if such a corporation maintains an office or other place of business in North Carolina, owns business property in this State, or meets the doing business definition, it is subject to the tax.
4. Tax Rate and Basis for the Tax (G.S. § 105-130.3, G.S. § 105-130.3C, G.S. § 105-130.4)
An income tax is levied on the State net income of all corporations chartered or doing business in North Carolina unless they are specifically exempt from tax under G.S. §§ 105-130.11 and 105-131.1. State net income is taxable income as defined in the Internal Revenue Code (“Code”) in effect for the income year for which the returns are to be filed, subject to the adjustments provided in G.S. § 105-130.5. The rates are as provided below:
Tax Year Beginning on or after Tax Rate
1/1/2014 6.0%
1/1/2015 5.0%
1/1/2016 4.0%
1/1/2017 3.0%
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In the case of a corporation that has business operations both within and without North Carolina; its net taxable income shall be allocated and apportioned to this State in accordance with G.S. § 105-130.4.
5. Corporations Required to Allocate and Apportion Income (G.S. § 105-130.4, 17 NCAC 05C.0601 and .0701)
A corporation must have business income from North Carolina and at least one other state to apportion and allocate its income. When a corporation is only taxable in another state as a result of nonapportionable income, then all apportionable income is attributed to North Carolina.
A corporation taxable both within and without North Carolina is required to use the allocation and apportionment provisions of G.S. § 105-130.4 to calculate its net income or net loss to North Carolina. For purposes of allocation and apportionment, a corporation is taxable in another state if:
 The corporation’s business activity in that state subjects it to a net income tax or a tax measured by net income; or
 That state has jurisdiction based on the corporation’s business activity in that state to subject the corporation to a tax measured by net income regardless of whether that state exercises its jurisdiction.
“Business activity” includes any activity by a corporation that would establish a taxable nexus pursuant to 15 United States Code, Section 381 (P.L. 86-272), based on North Carolina standards for doing business in this State. The filing of a unitary-combined return in another state with other related corporations does not, by itself, constitute “business activity” for purposes of determining if a corporation subject to income tax in this state is allowed to allocate and apportion income.
6. When in Doubt as to Liability
Any foreign corporation operating in North Carolina that is not certain of its tax status should promptly apply to the Department for a determination of its status. Complete detailed information as to the corporation’s operations should be submitted. All correspondence concerning the matter should be addressed to the Voluntary Disclosure Program, N.C. Department of Revenue, P.O. Box 871, Raleigh, N.C. 27602-0871.
7. Tax Forms
Corporation tax returns, Form CD-405 or Form CD-401S, are available from the Department’s web site at:
http://www.dornc.com/downloads/corporate.html.
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B. Tax Credits
Taxpayers are allowed various tax credits in Chapter 105 of the General Statutes that could be used to reduce corporate income tax (for credits applicable to Franchise Tax, see the Franchise Tax section of the 2017 Technical Bulletins). The following is a list of income tax credits that were repealed effective for tax years beginning on or after January 1, 2015:
 Credit for Rehabilitating Income-Producing Historic Structure - G.S. § 105-129.35
 Credit for Rehabilitating Nonincome-Producing Historic Structure - G.S. § 105-129.36
 Credit for Low Income Housing Awarded a Federal Credit Allocated on or after January 1, 2003 - G.S. § 105-129.42
 Credit for Income-Producing Rehabilitated Mill Property - G.S. § 105-129.71
 Credit for Nonincome-Producing Rehabilitated Mill Property - G.S. § 105-129.72
 Credit for Qualifying Expenses of a Production Company - G.S. §§ 105-130.47 and 105-151.29
These credits expired for tax years beginning on or after January 1, 2015.
 Credit for Investing in Renewable Energy Property - G.S. § 105-129.16A
 Credit for Donating to a Nonprofit Organization to Acquire Renewable Energy Property - G.S. § 105-129.16H
 North Carolina Research & Development - G.S. § 105-129.55
These credits expired for tax years beginning on or after January 1, 2016.
 Credit for Manufacturing Cigarettes for Exportation - G.S. § 105-130.45
 Credit for Manufacturing Cigarettes for Exportation While Increasing Employment and Utilizing State Ports - G.S. § 105-130.46
This credit will expire for tax years beginning on or after January 1, 2018.
- Credit for Constructing a Railroad Intermodal Facility - G.S. § 105-129.96
This credit will expire for tax years beginning on or after January 1, 2038.
For more specific information on these and the Article 3L Credit for Rehabilitation Income and Non-Income Producing Historic Property, see the Tax Credits section of the 2017 Technical Bulletins.
C. Computation of Net Income (G.S. §§ 105-130.3 and G.S. 105-130.5)
1. Preliminary Statement
A corporation uses its federal taxable income, as defined in the Code in effect for the tax year for which the return is to be filed, as its beginning point and adds or deducts the items listed below to compute State net income or loss. 23
A corporation may attach a copy of its Federal income tax return and supporting schedules in lieu of completing the corresponding schedules in its State return.
2. Adjustments to Federal Taxable Income
The following additions to Federal taxable income must be made in determining State net income:
a..Taxes based on or measured by net income by whatever name called and excess profits taxes.
b. Interest paid in connection with income exempt from State income taxation. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property.”
c. The contributions deduction allowed by the Internal Revenue Code.
d. Interest income earned on bonds and other obligations of other states or their political subdivisions, less allowable amortization on any bond acquired on or after January 1, 1963.
e. The amount by which gains have been offset by the capital loss carryover allowed under the Internal Revenue Code. All gains recognized on the sale or other disposition of assets are included in determining State net income or loss in the year of disposition.
f. Any amount allowed as a net operating loss deduction allowed by the Internal Revenue Code.
g. Payments to or charges by a parent, subsidiary or affiliated corporation in excess of fair compensation in any intercompany transaction.
h. The amount of all income tax credits claimed against the corporation’s income tax liability during the income year. In lieu of the add-back of tax credits to federal taxable income, taxpayers must reduce the amount of credit available by the current income tax rate. See Form CD-425, available at:
http://www.dor.state.nc.us/downloads/corporate.html.
i. Percentage depletion in excess of cost depletion applicable to mines, oil and gas wells and other natural deposits located outside this State.
j. The amount allowed under the Code for depreciation or as an expense in lieu of depreciation for a utility plant acquired by a natural gas local distribution company, to the extent the plant is included in the company’s rate base at zero cost in accordance with G.S. § 62-158.
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k. Royalty payments for the use of intangible property in this State made to a related member and deducted as an expense by a payer in arriving at federal taxable income if the election is made under G.S. § 105-130.7A for the recipient to exclude the royalty income from its income. A taxpayer making this election does not relieve the recipient from filing a North Carolina income tax return or apportioning royalty income pursuant to G.S. 105-130.4.
For purposes of G.S. § 105-130.7A, intangible property is defined as copyrights, patents, and trademarks. A taxpayer is not required to add back royalty payments for the use of intangible property in this State to a related recipient if the related recipient is organized under the laws of another country, that country has a comprehensive income tax treaty with the United States, and that country imposes a tax on the royalty income of the recipient at a rate that is equal to or exceeds the State’s corporate income tax rate.
l. The gross income from international shipping activities excluded from federal taxable income because the corporation elects to be subject instead to a tonnage tax under subchapter R of Chapter 1 of the Code.
m. The gross income from domestic production activities excluded from federal taxable income under section 199 of the Code.
n. The dividends paid deduction allowed to a captive Real Estate Investment Trust (“REIT”). A captive REIT is one whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are more than fifty percent (50%) owned or controlled by a person subject to North Carolina corporate income tax. REITs owned by other REITs or listed Australian property trusts are excluded from the definition.
o. The amount of a donation to a nonprofit organization or a unit of State or local government for acquisition or lease of renewable energy property made by a taxpayer who claimed a tax credit under G.S. § 105-129.16H.
p. The amount of income deferred under section 108(i)(1) of the Code from discharge of indebtedness in connection with a reacquisition of an applicable debt instrument.
q. The amount allowed as a deduction under section 163(e)(5)(F) of the Code for an original issue discount on an applicable high yield discount obligation.
r. The amount required to be added under G.S. § 105-130.5B when the State decouples from federal accelerated depreciation and expensing. See section 4, Adjustments When State Decouples From Bonus Depreciation and Section 179 Expenses.
s. The amount of net interest expense as determined under G.S. § 105-130.7B.
The following deductions from Federal taxable income must be made in determining State net income:
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a. Interest from obligations of the United States or its possessions, net of related expenses, to the extent included in federal taxable income. However, interest on obligations of the United States shall not be an allowable deduction unless interest from obligations of the State of North Carolina or any of its political subdivisions is exempt from income tax imposed by the United States.
b. Interest (net of expenses) received from obligations of the State of North Carolina, a political subdivision of this State, a commission, authority, or another agency of this State, a nonprofit educational institution organized or chartered under the laws of this State, and a hospital authority created under G.S. § 131E-17, to the extent the amounts are included in federal taxable income.
c. Payments received from a parent, subsidiary, or affiliated corporation in excess of fair compensation in intercompany transactions which were not allowed as a deduction for North Carolina income tax purposes by such corporation(s).
d. Dividends treated as received from sources outside the United States, as determined under section 862 of the Code, net of related expenses, to the extent included in federal taxable income. The netting of related expenses is calculated in accordance with G.S. §§ 105-130.5(c)(3) and 105-130.6A.
e. Any amount included in federal taxable income under section 78 or section 951 of the Code, net of related expenses.
f. For years prior to those beginning on or after January 1, 2015, net economic losses incurred by the corporation in any or all of the fifteen (15) preceding years pursuant to the provisions of G.S. § 105-130.8. For tax years beginning on or after January 1, 2015, state net losses are calculated under the provisions of G.S. § 105-130.8A. For specific instructions with respect to net economic loss and state net loss determinations see Subject: “State Net Loss Deduction and Net Economic Loss Carry-Over.”
g. Contributions or gifts made by the corporation within the income year to the extent provided under G.S. § 105-130.9. See Subject: “Deduction of Contributions.”
h. The amount of losses realized on the sale or other disposition of assets not allowed under section 1211(a) of the Internal Revenue Code. All losses recognized on the sale or other disposition of assets must be included in determining State net income or loss in the year of disposition.
i. The portion of undistributed capital gains of regulated investment companies included in federal taxable income and on which the federal tax paid by the regulated investment company is allowed as a credit or refund to the shareholder under section 852 of the Internal Revenue Code.
j. The amount by which the basis of a depreciable asset has been reduced on account of a tax credit allowed for federal tax purposes or a Section 1603 grant. 26
k. The amount of natural gas expansion surcharges collected by a natural gas local distribution company under G.S. § 62-158.
l. To the extent included in federal taxable income, the amount of 911 charges imposed under G.S. § 62A-43 and remitted to the 911 Fund under that section.
m. Royalty payments received for the use of intangible property in this State by a recipient from a payer that is a related member, if the election is made under G.S. § 105-130.7A for the payer to exclude the royalty payments from its expenses deduction. For purposes of G.S. § 105-130.7A, intangible property is defined as copyrights, patents, and trademarks.
n. The amount of dividend received from a captive Real Estate Investment Trust. A captive REIT is one whose shares or certificates of beneficial interest are not regularly traded on an established securities market and are more than fifty percent (50%) owned or controlled by a person subject to NC corporate income tax. REITs owned by other REITs or listed Australian property trusts are excluded from the definition.
o. The amount of deferred income added to federal taxable income under IRC section 108(i)(1).
p. The amount allowed as a deduction under G.S. § 105-130.5B resulting from the add-back of federal income tax accelerated depreciation or expensing of assets. See section 4, Adjustments When State Decouples from Bonus Depreciation and Expensing.
q. The amount of qualified interest expense to a related member as determined under G.S. § 105-130.7B.
Other adjustments to Federal taxable income that must be made in determining State net income are listed below:
a. In determining State net income, no deduction shall be allowed for annual amortization of bond premiums applicable to any bond acquired prior to January 1, 1963. The amount of premium paid on any such bond shall be deductible only in the year of sale or other disposition.
b. Federal taxable income must be increased or decreased to account for any difference in the amount of depreciation, amortization, or gains or losses applicable to property that has been depreciated or amortized by use of a different basis or rate for State income tax purposes than used for federal income tax purposes prior to January 1, 1967.
c. No deduction is allowed for any direct or indirect expenses related to income not taxed, except no adjustment is made under this subsection for adjustments addressed in G.S. §§ 105-130.5(a) and (b). See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property.”
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d. Federal taxable income must be adjusted in instances where the taxable income change caused by the recovery of previously deducted amounts may be different for state income tax purposes.
e. Depreciation recapture under Federal provisions must also be included in State net income. Since depreciation recapture is included in the corporation’s federal taxable income, no adjustment is necessary in computing its State net income.
3. Unrealized Income from Installment Sales Taxable upon Termination of Business
A corporation that withdraws, dissolves, merges, or consolidates its business, or terminates its business in this State by any other means whatsoever is required to file a final income tax return within one hundred five (105) days after the close of business. If the corporation uses the installment method of reporting income, all unrealized or unreported income from installment sales made while doing business in this State must be included in State net income on the final return.
4. Adjustments When State Decouples from Bonus Depreciation and Section 179 Expensing (G.S. § 105-130.5B)
a. General
North Carolina law differs from the Code with respect to bonus depreciation under sections 168(k) and (n). In addition, adjustments may be required for amounts deducted under section 179 of the Code. For tax years beginning on or after January 1, 2013 taxpayers are required to make a bonus asset basis adjustment if an asset is transferred and the tax basis of the asset carries over from the transferor to the transferee for federal income tax purposes.
b. Bonus Depreciation Deduction
Taxpayers cannot deduct the full amount of bonus depreciation deduction for federal income tax purposes in the year allowed under sections 168(k) and (n). Instead (except for property placed into service in 2009 discussed below), taxpayers are required to add back eighty-five percent (85%) of the federal bonus deprecation in the year taken for federal income tax. Taxpayers may deduct 20% of the total amount of bonus depreciation added to federal taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back into income. Thus, the federal bonus depreciation deduction is spread over six taxable years for North Carolina income tax purposes.
Taxpayers that placed property in service in 2009 and took bonus depreciation under section 168(k) in 2009 are required to treat these amounts as placed into service in 2010, and add-back 85% of the bonus depreciation taken in the 2009 tax year to it federal taxable income for the 2010 income tax year. Subsequently, beginning with for tax year 2011, taxpayers are allowed to deduct 20% of the amount of bonus depreciation added to taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back in income for the five tax years following 2010. 28
The adjustments do not result in a basis difference for federal and State income tax purposes, except as discussed in Section d, below.
c. Section 179 Expenses
For tax years 2010 through 2014, North Carolina did not entirely conform to section 179 expensing allowed for federal income tax purposes. Instead, North Carolina had separate dollar and investment limitations, as follows:
Tax Year NC Dollar Limitation NC Investment Limitation
2010 $ 250,000 $ 800,000
2011 $ 250,000 $ 800,000
2012 $ 250,000 $ 800,000
For tax years beginning on or after 2013, the NC Dollar Limitation is $25,000 and the NC Investment Limitation is $200,000.
Taxpayers placing section 179 property into service during these years are required to add to federal taxable income 85% of the section 179 deductions in excess of the amount allowed using the North Carolina limits. Taxpayers may subsequently deduct 20% of the amount of bonus depreciation added to taxable income in each of the first five taxable years following the year the taxpayer is required to include the add-back into income.
The adjustments do not result in a basis difference for federal and State income tax purposes, except as discussed in Section d, below.
For additional information regarding section 179 expenses, see:
http://www.dornc.com/taxes/individual/impnotice062014.pdf
d. Bonus Asset Basis Adjustments
A bonus asset basis adjustment is required when the following occurs:
a) There is an actual or deemed transfer of an asset occurring on or after January 1, 2013; and
b) The tax basis of the transferred asset carries over from the transferor to the transferee (i.e., the taxpayer) for federal income tax purposes.
To make an asset basis adjustment, a taxpayer must add any remaining bonus depreciation deductions associated with the transferred asset to the basis of the transferred asset and depreciate the adjusted basis over the remaining life of the asset. The remaining life of the asset is the remaining years in the asset’s federal recovery period, as determined under section 168(c) of the Code. 29
In addition, upon disposition of the asset, adjusted gross income must be increased or decreased to account for any differences in the basis for State and federal income tax purposes.
For examples and additional information of bonus asset basis adjustments, please refer to the Individual Income Tax Bulletin, Section IV, and “Bonus Asset Basis” at:
http://www.dornc.com/taxes/bonus_asset.html.
D. Interest Income on Government Obligations (G.S. § 105-130.3, G.S. § 105-130.5)
1. North Carolina Obligations (17 NCAC 05C.0401)
Net interest income received by a corporation on obligations of the State of North Carolina and any of its cities, towns or counties is exempt from income taxes imposed by this State.
For examples of North Carolina obligations exempt from corporate income tax on interest income and gains, see www.dornc.com/taxes/individual/ncobligations.html.
2. Obligations of Other States (17 NCAC 05C.0402)
Net interest income earned by a corporation on its investments in obligations issued by states and their political subdivisions, other than the State of North Carolina, represents taxable income and is subject to this State’s income tax.
3. U.S. Obligations (17 NCAC 05C.0403)
Net interest income earned on bonds, notes or other obligations of the United States or its possessions is exempt from income taxation in this State so long as interest on obligations of the state of North Carolina and its political subdivisions is exempt from income taxes imposed by the United States.
For detailed information on U.S. obligations exempt from tax, see:
www.dornc.com/taxes/individual/usnc.html.
4. Sales or Exchanges (17 NCAC 05C.0404)
Gain or loss realized on the sale or other disposition of any type of obligation of the United States or its possessions, the State of North Carolina or its political subdivisions, any other state or its political subdivisions, or of any other government is a taxable transaction and must be included in the computation of a corporation’s State taxable income.
Gain or loss realized on the sale or other disposition of obligations of the State of North Carolina or its political subdivisions issued before July 1, 1995 is not included in taxable 30
income if North Carolina law under which the obligations were issued specifically exempts the gain or interest from taxation.
For examples of North Carolina obligations exempt from corporate income tax on interest income and gains, see:
www.dornc.com/taxes/individual/ncobligations.html.
5. Obligations of Federal National Mortgage Association (17 NCAC 05C.0405)
Interest income or other income realized on obligations of Federal National Mortgage Association is taxable income.
6. Mortgage Backed Certificate Guaranteed by Federal Agencies (17 NCAC 05C.0406)
Interest paid by the issuer to the holder of a mortgage backed certificate guaranteed by the Federal Government, corporations formed by the Federal Government and/or Federal Agencies is not income from an obligation of the United States Government and is taxable.
7. Repurchase Agreements (17 NCAC 05C.0407)
Income attributable to or received from repurchase agreements of U.S. government securities, an agreement to repurchase securities at an agreed price and date, is not considered income derived directly from federal obligations and is taxable income.
E. Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property (G.S. § 105-130.4, G.S. § 105-130.5, 17 NCAC 05C.0304)
1. Direct Expenses
All expenses directly connected with the production of income not subject to tax in this State are required to be used to compute the net amount of such untaxed income.
2. Interest Expense
When a corporation earns income which is not taxed by this State (see examples), and/or holds property that does or will produce untaxed income, and incurs interest expense, which is not specifically related to any particular income or property, it must attribute a portion of the interest expense to such untaxed income and property in determining taxable income reported to this State. The formula for computing the amount of interest expense to be attributed to untaxed income and property is as follows:
a. Assets
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i. Value on the tax return balance sheet of assets that produce or which would produce untaxed income. (When the equity method of accounting is used, the increase or decrease in value as result of such accounting may be excluded from this value.)
ii. Value of all assets on the tax return balance sheet. (Equity included in this value may be excluded and the reserve for depreciation reflected on the balance sheet may be restored to the asset value.)
iii. Determine the ratio or percentage of i to ii
b. Income
i. Gross Untaxed Income
ii. Total Gross Profits
iii. Determine the ratio or percentage of i to ii
c. Total of the ratios or percentages determined in a and b above.
d. Divide total of c by 2
e. Apply average percentage determined in d to the total interest expense on the return filed in this State.
Examples of untaxed income:
 Dividend income not taxed, including dividends excluded by section 243 of the Code and dividends classified as nonapportionable (G.S. §§ 105-130.4, 105-130.5(c)(3))
 Interest income classified as nonapportionable (G.S. § 105-130.4)
 Interest income earned on obligation of the United States and the State of North Carolina.
 Other nonapportionable income and/or exempt income
3. Expense Connected With Interest Income From United States Obligations
Under G.S. § 105-130.5(b)(1), interest income from obligations of the United States or its possessions is excludable from North Carolina taxable income to the extent such income is included in federal taxable income. Since federal taxable income is in effect a net income, expenses incurred in producing the exempt income must be determined and subtracted from the gross amount earned during a taxable period before the deduction is made in computing the state taxable income. The basis for requiring this adjustment to exempt income is based on federal case law. (First National Bank of Atlanta v. Bartow County Board of Tax Assessors, 470 U.S. 583, 84 L. Ed. 2d 535 (1985) and supported by an advisory opinion of the North Carolina Attorney General.)
In the computation of expenses related to income from United States obligations, the formula described above in Item 2 may be used with respect to interest expense.
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4. Dividends (G.S. §§ 105-130.5(b)(3a) and (c)(3))
For tax years beginning on or after January 1, 2016, expenses attributed to dividends not tax for North Carolina income tax purposes cannot exceed 15%.
5. Other Expenses Attributed to Nontaxable Income and to Nonapportionable Income and Property
In the determination of expenses other than interest expense attributed to untaxed income, the methodologies set forth in the Code for determining expenses related to foreign source income generally referred to as stewardship and supportive expenses may be used to determine the expenses allocated to untaxed income and property producing or which would produce untaxed income.
Alternatively, an income formula as outlined in Item 2 above may be used to determine the amount of supportive function expenses attributable to untaxed income. In determining “supportive function expenses”, direct expenses incurred exclusively in a specific identifiable taxable or nontaxable activity should be excluded before applying the attribution percentage to expenses. If direct expenses are determinable for a particular activity resulting in an accurate computation of the net income or loss from such activity, the values of this activity are removed from the two ratios when computing the attribution percentage.
F. Related Entity Interest Deduction Limitation (G.S. § 105-130.7B)
1. Preliminary Statement
For tax years beginning on or after January 1, 2016, a corporation may only deduct the amount of qualified interest expense from a related member, as defined in G.S. § 105-130.7A, unless an exception applies.
2. Qualified Interest Expense
Qualified interest expense is the greater of the amount of interest paid or accrued from a related member up to 15% of the taxpayer’s adjusted taxable income as computed without a deduction for related party interest unless an exception applies, or the taxpayer’s proportional share of interest. The 15% limitation does not apply to amounts that qualify for an exception under G.S. § 105-130.7B(4).
A taxpayer’s proportionate share of interest is
a. The amount paid or accrued directly to or through a related member to an ultimate payer, divided by
b. The total net interest expense of all related members paid or accrued directly through a related member to the same ultimate payer, multiplied by
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c. The interest amount paid or accrued by the ultimate payer to an unrelated party. Amounts distributed, paid, or accrued through a related member that is not treated as interest for North Carolina income tax purposes does not qualify.
The ultimate payer is the related member that receives or accrues interest directly or indirectly from other related members and pays or accrues interest to an unrelated entity.
3. Exceptions
The 15% limitation does not apply if
a. An income tax is imposed by North Carolina on the amount of interest income received by the related member;
b. An income or gross receipts tax is imposed by another state on the related member with respect to the interest income;
c. The related member is an entity organized under the laws of a foreign country that has a comprehensive tax treaty with the United States and taxes the interest income at a rate equal to or greater than provided under G.S. § 105-130.3; or
d. The related member is a bank. For the purposes of this section, a bank includes a bank holding company as defined in the Bank Holding Company Act of 1956; a bank, savings bank, savings and loan association, or trust company, as each is defined in G.S. §§ 53C, 54B, and 54C; or a subsidiary or affiliate of any of these entities.
G. Allocation and Apportionment Procedures (G.S. § 105-130.4)
1. Preliminary Statement
A corporation that is taxable both within and without North Carolina is required to allocate and apportion its entire net income or loss to North Carolina in accordance with the statutory formula under G.S. § 105-130.4.
No corporation is allowed to use any alternative formula or method of reporting its income to North Carolina except upon written order of the Secretary of Revenue. Any return in which any formula or method other than as prescribed by statute is used without the permission of the Secretary is not a lawful return.
2. Alternate Apportionment Formula (17 NCAC 05D.0107-.0115)
If a C corporation, S corporation, or limited liability company electing to be taxed as either a C or S corporation for federal income tax purposes, believes that the statutory apportionment formula subjects a greater portion of its income than is reasonably attributable to business or earnings in this State, it may make a written request with the Secretary of Revenue for permission to use an alternate apportionment formula. The request must set out the reasons for 34
the corporation’s belief and propose an alternative method. The corporation has the burden of proof for demonstrating why the statutory method subjects it to taxation on a greater proportion of income than is reasonable attributable to North Carolina.
The written request must be made with the Secretary not later than ninety (90) days after the regular or extended due date of the tax return. Taxpayers should address all correspondence in connection with such petitions to the Secretary of Revenue, Department of Revenue, PO Box 871, Raleigh, NC 27602-0871. The Secretary will schedule a conference to hear the corporation’s request. The Secretary and the Director of the Income Tax Division and/or their designee(s) will attend the conference. The taxpayer is not required to appear or be represented at the conference; however, an authorized representative may appear on behalf of, or in addition to, the taxpayer.
The Secretary must issue a written decision on a corporation’s request for an alternative apportionment method within sixty days from the date of the conference or sixty days after the date any requested additional information is provided. The decision can apply to no more than three years. A corporation may renew a request to use an alternative apportionment method by reapplying to the Secretary of Revenue. A corporation authorized to use an alternative formula may apportion its Net Worth base using the alternative method or the statutory method.
If the Secretary finds the statutory method does not fairly represent the corporation’s activities in the State, remedies include requiring separate accounting, inclusion or exclusion of one or more factors, or any other method that results in equitable apportionment and allocation of income. If the request is for both income and franchise tax, a separate determination will be made for each tax.
If the request is denied, the Secretary’s decision is final and is not subject to administrative or judicial review. A corporation may not use an alternative apportionment method except upon written order by the Secretary, and any return filed using a method other than the statutory method without the Secretary’s permission is not a lawful return.
3. Statutory Procedures for Reporting Net Income or Loss to North Carolina
a. Determine North Carolina Taxable Income
A corporation must determine its State net income or loss from its entire operations conducted everywhere during the income year in accordance with the instructions given in the subject “Computation of Net Income.” In computing such net income only contributions to donees outside North Carolina are deductible. Contributions to qualified North Carolina donees are deductible only from total income allocated to North Carolina, computed in Step h.
b. Determine Nonapportionable Income
A corporation must review its entire net income or loss as computed in Step a to determine whether any items of nonapportionable income, loss and expense qualify for direct allocation 35
to North Carolina and other states pursuant to G.S. § 105-130.4, subdivisions (d) through (h). Any expenses directly and/or indirectly related to an activity that produces nonapportionable income must be considered in the computation of nonapportionable income to be allocated. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property”.
c. Determine Apportionable Income
A corporation determines its apportionable income or loss by deducting all nonapportionable income or loss directly allocable to North Carolina and other states (computed in Step b) from its entire net income or loss (computed in Step a).
d. Compute Apportionment Factors
A corporation is required to determine and compute the apportionment factor applicable to its principal business operations conducted everywhere during the income year. When the income from specific property constitutes nonapportionable income, the value of such property and items of nonapportionable income, loss, and expense directly allocable to North Carolina and other states must be excluded in computing the apportionment factors.
e. Income Apportioned to North Carolina
A corporation determines the amount of its apportionable income or loss attributable to North Carolina by applying the factor computed in Step d to apportionable income or loss as computed in Step c.
f. Determine Nonapportionable Income Allocated to North Carolina
A corporation should review the total amount of nonapportionable income or loss as computed in Step b and list separately the amount of such income or loss directly allocable to North Carolina. This amount, added to the amount of apportionable income or loss apportioned to this State in Step e, represents the total amount of the corporation’s entire net income or loss that is subject to North Carolina tax.
g. Percentage Depletion Deduction Before Net Economic or State Net Loss Deduction
The amount of percentage depletion over cost depletion on North Carolina property must be deducted before claiming any net economic or state net loss carryover deduction.
h. Determine Income Before Contributions to North Carolina Donees
To determine total North Carolina income before the deduction for contributions to North Carolina donees, a corporation deducts the allowable portion of any net economic loss or State net loss for a prior year or years from the total income determined as described in Step g.
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i. Determine Net Taxable Income
Finally, a corporation arrives at its net taxable income in North Carolina by deducting contributions made to qualified North Carolina donees from the amount of total North Carolina income as computed in Step h.
H. Taxable in Another State (G.S. § 105-130.4)
1. Preliminary Statement (17 NCAC 05C.0601)
A taxpayer must have income from business activity taxable by this State and at least one other state to allocate and apportion income. Income from business activity includes apportionable or nonappportionable income. Thus, if a taxpayer has nonapportionable income taxable by one state and apportionable income taxable by another state, the taxpayer’s income must be allocated and apportioned in accordance with G.S. § 105-130.4. Where a corporation is not taxable in any other state on its apportionable income but is taxable in another state only because of nonapportionable income, all apportionable income is attributed to this State.
2. Definition of Taxpayer (17 NCAC 05C.0602)
The word “taxpayer” includes any corporation subject to the tax imposed by Article 4 of Chapter 105 of the General Statutes.
3. Taxable in Another State
A taxpayer is “taxable in another state” if it meets either one of two tests:
1.If by reason of business activity in another state the taxpayer is “subject to” a net income tax or any other tax measured by net income.
2.If another state has jurisdiction to subject the taxpayer to a net income tax based on business activity regardless of whether or not that state imposes such a tax on the taxpayer.
4. Taxable in Another State – When A Corporation is “Subject To” Tax (17 NCAC 05C.0604)
a. A taxpayer is “subject to” one of the taxes specified above only if it carries on business activities in another state. If the taxpayer voluntarily files and pays such tax when not required by the laws of that state or pays a minimal fee for qualification, organization or for the privilege of doing business in that state, but
 Does not actually engage in business activities in that state, or
 Does actually engage in some activity not sufficient for nexus and the minimum tax bears no relation to the corporation’s activities within such state, the taxpayer is not “subject to” tax within that state and is therefore not “taxable” in another state.
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Example: State A has a corporation franchise tax measured by net income for the privilege of doing business in that state. Corporation X files a return and pays the fifty dollars ($50) minimum tax, although it carries on no activities in State A. Corporation X is not “taxable” in State A.
b. The concept of taxability in another state is based upon the premise that every state in which the taxpayer is engaged in business activities may impose an income tax even though every state does not do so. In some states, other types of taxes may be imposed as a substitute for an income tax. Therefore, only those taxes which may be considered as basically revenue generating rather than regulatory measures shall be considered in determining whether the taxpayer is “taxable in another state.”
Example 1: State A requires all nonresident corporations which qualify or register in State A to pay to the Secretary of State an annual license fee or tax for the privilege of doing business in the state regardless of whether the privilege is in fact exercised. The amount paid is determined according to the total authorized capital stock of the corporation; the rates are progressively higher by bracketed amounts. The statute sets a minimum fee of fifty dollars ($50) and a maximum fee of five hundred dollars ($500). Failure to pay the tax bars a corporation from utilizing the state courts for enforcement of its rights. State A also imposes a corporation income tax. Nonresident Corporation X is qualified in State A and pays the required fee to the Secretary of State but does not carry on any activities in State A other than utilizing its courts. Corporation X is not “taxable” in State A.
Example 2: Same facts as Example 1 except that Corporation X has sufficient business activities in State A to establish nexus under the criteria followed in this state and is, therefore, subject to and pays the corporate income tax. Corporation X is “taxable” in State A.
Example 3: State B requires all nonresident corporations qualified or registered in State B to pay to the Secretary of State an annual permit fee or tax for doing business in the state. The base of the fee or tax is the sum of (1) outstanding capital stock, and (2) surplus and undivided profits. The fee or tax base attributable to State B is determined by a three-factor apportionment formula. Nonresident Corporation X, which operates a plant in State B, pays the required fee or tax to the Secretary of State. Corporation X is “taxable” in State B because of its business activities there.
Example 4: State C has a corporation franchise tax measured by net income for the privilege of doing business in that state. Corporation X files a return based upon its business activities in the state but the amount of computed liability is less than the minimum tax. Corporation X pays the minimum tax. Corporation X is “taxable” in State C.
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5. Taxable in Another State – When a State has Jurisdiction to Subject a Taxpayer to a Net Income Tax (17 NCAC 05C.0605)
The second test in Example 3 above applies if the taxpayer’s business activities are sufficient to give the state jurisdiction to impose a net income tax under the Constitution and statutes of the United States. Jurisdiction to tax is not present where the state is prohibited from imposing the tax by reason of the provisions of Public Law 86-272, 15 U.S.C.A. §§ 381-385. In the case of any “state”, as defined in G.S. § 105-130.4, other than a state of the United States or political subdivision of each state, the determination of whether such “state” has jurisdiction to subject the taxpayer to a net income tax shall be made as though the jurisdictional standards applicable to a state of the United States applied in that “state”. If jurisdiction is otherwise present, such “state” is not considered as without jurisdiction by reason of the provisions of a treaty between that state and the United States.
Example: Corporation X is actively engaged in manufacturing farm equipment in State A and in Foreign Country B. Both State A and Foreign Country B impose a net income tax but Foreign Country B exempts corporations engaged in manufacturing farm equipment. Corporation X is subject to the jurisdiction of State A and Foreign Country B.
I. Apportionable and Nonapportionable Income (G.S. § 105-130.4)
1. Division of Income – In General (17 NCAC 05C.0701)
When a taxpayer has income from sources within this State as well as income from sources outside this State, the division of income and the resulting determination of the portion of the taxpayer’s entire net income that is attributable to this State shall be determined pursuant to the allocation and apportionment provisions set forth in G.S. § 105-130.4. In such cases, the first step is to determine which portion of the taxpayer’s entire net income constitutes “apportionable income” and which portion constitutes “nonapportionable income”. The various items of nonappportionable income are then directly allocated to specific jurisdictions pursuant to the provisions of subsections (d) through (h) of G.S. § 105-130.4. The apportionable income of the taxpayer other than public utilities, excluded corporations, and qualified capital intensive corporations is divided between the jurisdictions in which the business is conducted pursuant to the property, payroll and sales apportionment factors set forth in subsections (j) though (1) of G.S. § 105-130.4. The sum of (1) the items of nonapportionable income directly allocated to this State, plus (2) the amount of apportionable income attributable to this State by the apportionment formula generally constitutes the amount of the taxpayer’s entire net income that is subject to tax under the income tax laws of this State.
The taxpayer shall classify income as apportionable or nonapportionable income on a consistent basis. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
The word “apportionment” generally refers to the division of net income between jurisdictions by the use of a formula containing apportionment factors, and the word “allocation” generally refers to the assignment of net income to a particular jurisdiction. 39
2. Apportionable and Nonapportionable Income Defined (G.S. § 105.130.4)
“Apportionable income” is defined as all income that is apportionable under the United States Constitution. For purposes of administration of G.S. § 105-130.4, all income of a taxpayer is apportionable income unless clearly classifiable as nonapportionable income under the law and regulations. Nonapportionable income means all income other than apportionable income.
3. Apportionable and Nonapportionable Income – Application of Definitions
The classification of income by the labels customarily given them, such as interest, rents, royalties, and capital gains, is of no aid in determining whether that income is apportionable or nonapportionable income. The gain or loss recognized on the sale of property, for example, may be apportionable income or nonapportionable income depending upon the relation to the taxpayer’s trade or business. In general, all income from transactions and activites that are dependent upon or contribute to the operations of a taxpayer is apportionable. Income from unrelated activities is “nonapportionable” income.
4. Proration of Deductions Related to Apportionable and Nonapportionable Income (17 NCAC 05C.0704)
Any allowable deduction that is applicable both to apportionable and nonapportionable income or to more than one “trade or business” of the taxpayer is prorated to those classes of income or trades or businesses in determining income subject to tax. The taxpayer must be consistent in the proration of such deductions in filing returns under these regulations. See Subject: “Attribution of Expenses to Nontaxable Income and to Nonapportionable Income and Property”.
J. Apportionment Factors (G.S. § 105-130.4, G.S. § 105-130.4(i))
1. General Business Corporations
Corporations engaged in multistate business activity, other than public utilities, excluded corporations, and qualified capital intensive corporations are required to apportion to this State all apportionable income by using a four-factor formula. For tax years prior to those beginning on or after January 1, 2016, the apportionment formula consists of the sum of the property factor, the payroll factor and twice the sales factor divided by four. If the sales factor does not exist, the denominator is the number of existing factors. If a property or payroll factor does not exist, the denominator is the number of existing factors plus one. The only time a factor does not exist is when there is no denominator. When there is a denominator for a particular factor, but no numerator, the factor is zero and becomes part of the apportionment factor.
For tax years beginning on or after January 1, 2016, the apportionment factor will be calculated by adding the property factor, the payroll factor, and sales factor times three and dividing the result by five.
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For tax years beginning on or after January 1, 2017, the apportionment factor will be calculated by adding the property factor, the payroll factor, and sales factor times four and dividing the result by six.
For tax years beginning on or after January 1, 2018, all income will be apportioned using only the sales factor.
a. Property Factor (G.S. § 105-130.4) (This section is repealed effective for tax years beginning on or after January 1, 2018)
i. Property Factor – In General (17 NCAC 05C.0801)
The property factor includes all real and tangible personal property owned or rented and used during the income year to produce apportionable income. The term “real and tangible personal property” includes land, buildings, machinery, stocks of goods, equipment and other real and tangible personal property used in connection with the production of apportionable income but does not include coin or currency. See definition of “apportionable income”.
Property used in connection with the production of nonapportionable income that is allocated in accordance with subsections (d) through (h) of G.S. § 105-130.4 is excluded from the factor.
Property used in connection with the production of both apportionable and nonapportionable income is included in the factor only to the extent the property was used in connection with the production of apportionable income. The method of determining that portion of the value to be included in the factor will depend upon the facts of each case.
The property factor includes the average value of property includible in the factor.
ii. Property Factor – Property Used for the Production of Apportionable Income (17 NCAC 05C.0802)
Property is included in the property factor if it is actually used during the income year for the production of apportionable income. Property held as reserves or standby facilities or property held as a reserve source of materials shall be included in the factor. For example, a plant temporarily idle or raw material reserves not currently being processed are includible in the factor. Property that is permanently idle or idle for the entire taxable year generally is not included in the factor computation. Property or equipment under construction during the income year (except inventoriable goods in process) is excluded from the factor until such property is actually used for the production of apportionable income. If the property is partially used for the production of apportionable income while under construction, the value of the property to the extent used is included in the property factor.
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iii. Property Factor – Consistency in Reporting (17 NCAC 05C.0803)
The taxpayer must be consistent in the valuation of property and in excluding or including property in the property factor in filing returns with this State. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
iv. Property Factor – Numerator (17 NCAC 05C.0804)
The numerator of the property factor includes the average value of the taxpayer’s real and tangible personal property owned or rented and used in this State during the income year for the production of apportionable income.
Property in transit between locations of the taxpayer to which it belongs is considered to be at the destination for purposes of the property factor. Property in transit between a buyer and seller which is included by a taxpayer in the denominator of its property factor in accordance with its regular accounting practices is included in the numerator according to the state of destination.
The value of mobile or movable property such as construction equipment, trucks or leased electronic equipment which is located within and without this State during the income year is determined for purposes of the numerator of the factor on the basis of total time within the State during the income year. An automobile assigned to a traveling employee is included in the numerator of the factor of the state to which the employee’s compensation is assigned under the payroll factor or in the numerator of the state in which the automobile is licensed.
v. Property Factor – Valuation of Owned Property (17 NCAC 05C.0805)
Property owned by the taxpayer is valued at its original cost. “Original cost” of property which has a basis other than zero for federal income tax purposes equals the basis of the property for federal income tax purposes at the time of acquisition by the taxpayer and adjusted by subsequent capital additions or improvements thereto and partial disposition thereof, by reason of sale, exchange, abandonment, or any other type of disposition.
“Original cost” of property that has a zero basis for federal income tax purposes shall equal the taxpayer’s actual cost of the property at the time of acquisition. If the actual cost is unknown, the original cost shall equal the fair market value of the property, or, at the option of the taxpayer, eight times the net annual rental rate as described in G.S. § 105-130.4(j)(2). The valuation method chosen by the taxpayer must be used consistently thereafter.
Example 1: Taxpayer acquired a factory building in this State at a cost of five hundred thousand dollars ($500,000) and years later, expended one hundred thousand dollars ($100,000) for major remodeling of the building. Taxpayer files its return on the calendar year basis and claims a depreciation deduction in the amount of twenty-two thousand 42
dollars ($22,000) on the building. The value of the building includible in the numerator and denominator for the property factor is six hundred thousand dollars ($600,000), as the depreciation deduction is not taken into account in determining the value of the building for purposes of the factor.
Example 2: X corporation merges into Y corporation in a nontaxable reorganization under the Internal Revenue Code. At the time of the merger, X corporation owns a factory which X built years earlier at a cost of one million dollars ($1,000,000). X has been depreciating the factory at the rate of two percent (2%) per year, and its basis in X’s hands at the time of the merger is six hundred thousand dollars ($600,000). Since the property is acquired by Y in a transaction in which, under the Internal Revenue Code, the basis in Y’s hands is the same as the basis in X’s, Y includes the property in Y’s property factor at X’s original cost, without adjustment for depreciation, i.e., one million dollars ($1,000,000).
Example 3: Corporation Y acquires the assets of corporation X in a liquidation by which Y is entitled to use its stock cost as the basis of the X assets under the Internal Revenue Code. Under these circumstances, Y’s cost of the assets is the purchase price of the X stock, prorated over the X assets.
Example 4: Corporation X was deeded from local government a potential manufacturing facility (cost unknown) with a market value of one million dollars ($1,000,000) as an incentive for locating in the State. Since the property would have a zero basis for federal income tax purposes under section 118(a), Corporation X includes the one million dollars ($1,000,000) fair market value of the property in the computation of its property factor, or at X’s option may include eight times the net annual rental rate of the property.
Inventory of stock of goods is included in the factor in accordance with the valuation method used for federal income tax purposes, except when inventory is valued by use of the LIFO method, actual cost of the FIFO valuation method must be used.
Property acquired by gift or inheritance is included in the factor at its basis for determining depreciation for federal income tax purposes.
vi. Property Factor – Rented Property
Property rented by the taxpayer is valued at eight times the net annual rent paid during the current income year. Net annual rent is the total annual rent paid by the taxpayer less amounts received from subrentals. However, subrentals are not deducted when they constitute apportionable income. Rental values so determined are included in the numerator and denominator and are averaged by including such amounts at the beginning and at the end of the income year.
Example 1: The taxpayer receives subrents from a bakery concession in a food market operated by the taxpayer. The subrents are apportionable income and are not deducted from rent paid by the taxpayer for the food market.
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Example 2: The taxpayer rents a twenty-story office building and uses the lower two stories for its general corporation headquarters. The remaining eighteen (18) floors are subleased to others. The subrents are nonapportionable income and are to be deducted from the rent paid by the taxpayer.
“Annual rent” is the actual sum of money or other consideration payable, directly or indirectly, by the taxpayer or for its benefit for the use of the property and includes:
 Any amount payable for the use of real or tangible personal property, or any part thereof, whether designated as a fixed sum of money or as a percentage of sales, profits or otherwise.
Example: A taxpayer, pursuant to the terms of a lease, pays a lessor one thousand dollars ($1,000) per month as a base rental and at the end of the year pays the lessor one percent of its gross sales of four hundred thousand dollars ($400,000). The annual rent is sixteen thousand dollars ($16,000) (twelve thousand dollars ($12,000) plus one percent (1%) of four hundred thousand dollars ($400,000) or four thousand dollars ($4,000)).
 Any amount payable as additional rent or in lieu of rents, such as interest, taxes, insurance, repairs or any other items which are required to be paid by the terms of the lease or other arrangement, and does not include amounts paid as service charges, such as utilities, janitorial services, etc. If a payment includes rent and other charges unsegregated, the amount of rent is determined by consideration of the relative values of the rent and the other items.
Example 1: A taxpayer, pursuant to the terms of a lease, pays the lessor twelve thousand dollars ($12,000) a year rent plus taxes in the amount of two thousand dollars ($2,000) and interest on a mortgage in the amount of one thousand dollars ($1,000). The annual rent is fifteen thousand dollars ($15,000).
Example 2: A taxpayer stores part of its inventory in a public warehouse. The total charge for the year was one thousand dollars ($1,000) of which seven hundred dollars ($700) was for the use of storage space and three hundred dollars ($300) for inventory, insurance, handling and shipping charges and C.O.D. collections. The annual rent is seven hundred dollars ($700).
“Annual rent” does not include incidental day-to-day expenses such as hotel and motel accommodations, daily rental of automobiles, etc.
Leasehold improvements shall, for the purposes of the property factor, be treated as property owned by the taxpayer regardless of whether the taxpayer is entitled to remove the improvements or the improvements revert to the lessor upon expiration of the lease. Hence, the original cost of leasehold improvements is included in the factor.
vii. Property Factor – Averaging Property Values
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As a general rule the average value of property owned by the taxpayer is determined by averaging the values at the beginning and ending of the income year. However, the Secretary may require averaging by monthly or other periodic values if such method of averaging is required to properly reflect the average value of the taxpayer’s property for the income year.
Averaging by monthly or other periodic values will generally be applied if substantial fluctuations in the values of the property exist during the income year or where property is acquired after the beginning of the income year or disposed of before the end of the income year.
b. Payroll Factor (G.S. § 105-130.4) (This section is repealed effective for tax years beginning on or after January 1, 2018)
i. Payroll Factor – In General
The payroll factor includes the total amount paid by the taxpayer for compensation in connection with earning apportionable income during the income year.
ii. Payroll Accounting Method (17 NCAC 05C.0902)
The total amount “paid” to employees is determined upon the basis of the taxpayer’s accounting method. If the taxpayer has adopted the accrual method of accounting, all compensation properly accrued shall be deemed to have been paid. Notwithstanding the taxpayer’s method of accounting, at the election of the taxpayer, compensation paid to employees may be included in the payroll factor by use of the cash method if the taxpayer is required to report such compensation under such method for unemployment compensation purposes.
The taxpayer must be consistent in the treatment of compensation paid in filing returns with this State. In the event the taxpayer is not consistent in its reporting it must disclose in its return to this State the nature and extent of the inconsistency.
iii. The Term “Compensation” (17 NCAC 05C.0903)
Compensation means wages, salaries, commissions and any other form of remuneration paid to employees for personal services. Payments made to an independent contractor or any other person not properly classified as an employee is excluded. Only amounts paid directly to employees are included in the payroll factor. Amounts considered paid directly include the value of board, rent, housing, lodging and other benefits or services furnished to employees by the taxpayer in return for personal services provided that such amounts constitute income to the recipient under the Internal Revenue Code. In the case of employees not subject to the Internal Revenue Code, e.g., those employed in foreign countries, the determination of whether such benefits or services would constitute income to the employees is as though such employees were subject to the Internal Revenue Code.
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iv. The Term “Employee”
Employee means (1) any officer of a corporation, or (2) any individual who, under the usual common-law rules applicable in determining the employer-employee relationship, has the status of an employee. Generally, a person will be considered to be an employee if he is included by the taxpayer as an employee for purposes of the payroll taxes imposed by the Federal Insurance Contributions Act; except that, since certain individuals are included within the term “employees” in the Federal Insurance Contributions Act who would not be employees under the usual common-law rules, it may be established that a person who is included as an employee for purposes of the Federal Insurance Contributions Act is not an employee for purposes of this regulation.
v. Payroll Factor Includes Only Apportionable Income Compensation and Excludes Compensation Paid to General Executive Officers
The payroll factor includes only compensation that is attributable to income subject to apportionment. The compensation of any employee whose activities are connected primarily with nonapportionable income is excluded from the factor. All compensation paid to general executive officers is excluded in computing the payroll factor. General executive officers include the chairman of the board, president, vice-presidents, secretary, treasurer, comptroller and any other office serving in similar capacities.
Example 1: The taxpayer uses some of its employees in the construction of a storage building that, upon completion, is used for the production of apportionable income. The wages paid to those employees are treated as a capital expenditure by the taxpayer. The amount of such wages is included in the payroll factor.
Example 2: The taxpayer owns various securities from which nonapportionable income is derived. The management of the taxpayer’s investment portfolio is the only duty of Mr. X, an employee. The salary paid to Mr. X is excluded from the payroll factor.
vi. Denominator of Payroll Factor (17 NCAC 05C.0906)
Except as provided above, the denominator of the payroll factor is the total compensation paid everywhere during the income year. Accordingly, compensation paid to employees whose services are performed entirely in a state where the taxpayer is exempt from taxation, for example, by Public Law 86-272, is included in the denominator of the payroll factor.
Example: A taxpayer has employees in its state of legal domicile (State A) and is taxable in State B. In addition the taxpayer has other employees whose services are performed entirely in State C where the taxpayer is exempt from taxation by Public Law 86-272. As to these latter employees, the compensation will be assigned to State C where their services 46
are performed (i.e., included in the denominator only of the payroll factor) even though the taxpayer is not taxable in State C.
vii. Numerator of Payroll Factor (17 NCAC 05C.0907)
Except as provided above, the numerator of the payroll factor is the total amount paid in this State during the tax period by the taxpayer for compensation. If compensation paid to employees is included in the payroll factor by use of the cash method of accounting or if the taxpayer is required to report such compensation under such method for unemployment compensation purposes, it shall be presumed that the total wages reported by the taxpayer to this State for unemployment compensation purposes constitutes compensation paid in this State except for compensation excluded under Item v above. The presumption may be overcome by satisfactory evidence that an employee’s compensation is not properly reportable to this State for unemployment compensation purposes.
Compensation is paid in this State if any one of the following tests, applied consecutively, is met:
1. The employee’s service is performed entirely within the State.
2. The employee’s service is performed both within and without the State, but the service performed without the State is incidental to the employee’s service within the State. The word “incidental” means any service which is temporary or transitory in nature, or which is rendered in connection with an isolated transaction.
3. If the employee’s services are performed both within and without this State, the employee’s compensation will be attributed to this State if:
 The employee’s base of operations is in this State; or
 There is no base of operations in any state in which some part of the service is performed, but the place from which the service is directed or controlled is in this State; or
 The base of operations or the place from which the service is directed or controlled is not in any state in which some part of the service is performed, but the employee’s residence is in this State.
The words “base of operations” means the place of more or less permanent nature from which the employee starts his work and to which he customarily returns in order to receive instructions from the taxpayer or communications from his customers or other persons, or to replenish stock or other materials, repair equipment, or perform any other functions necessary to the exercise of his trade or profession at some other point or points.
The words “place from which the service is directed or controlled” refer to the place from which the power to direct or control is exercised by the taxpayer.
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viii. Corporations Utilizing Common Paymaster (17 NCAC 05C.0908)
A parent corporation or any corporation serving as common paymaster for payroll purposes shall eliminate from the numerator and denominator of its payroll factor computation the amounts paid on behalf of controlled members for which it has charged such member the exact cost and which does not meet the definition of compensation insofar as the common paymaster is concerned. The numerator and denominator of the payroll factor shall be determined in accordance with applicable statute after elimination of the described amounts.
A subsidiary or otherwise controlled corporation which is a member of and/or participant in a common paymaster plan for payroll purposes, shall include in its numerator and denominator of the payroll factor computation amounts paid to its parent corporation or to another corporation of the controlled group as reimbursement in whatever form and by whatever label for employees’ compensation as defined. The amounts paid by the subsidiary or controlled corporation includable in the numerator and the denominator of the payroll factor shall be determined in accordance with applicable statute.
c. Sales Factor (G.S. § 105-130.4)
i. Sales Factor – Sales Made in General Business Operations (17 NCAC 05C.1001)
G.S. § 105-130.4(a)(7) defines “sales” to mean all gross receipts of the taxpayer except receipts from the “casual sale” of property, receipts allocated under subsections (c) through (h) of G.S. § 105-130.4, receipts exempt from taxation, and the portion of receipts realized from the sale or maturity of securities or other obligations that represents a return of principal. For taxable years beginning January 1, 2016, sales also excludes the portion of receipts from financial swaps and other similar financial derivatives representing the notional principal amount that generates cash flow traded in the swap agreement, and dividends subtracted under G.S. § 105-130.5(b)(3a) and (3b), and dividends excluded from federal tax.
Thus, for the purposes of the sales factor, the term “sales” means generally all gross receipts derived by a taxpayer from transactions and activities in the course of its regular trade or business operations which produce apportionable income within the meaning of G.S. § 105-130.4(a)(1).
A “casual sale” of property means the sale of any property that was not purchased, produced, or acquired primarily for sale in the corporation’s regular trade or business.
In the case of a taxpayer whose business activity consists of manufacturing and selling or purchasing and reselling goods or products, “sales” includes all gross receipts from the sales of such goods or products (or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year) held by the taxpayer primarily for sale to customers in the ordinary course of its trade or business. Gross receipts means gross sales, less returns and allowances, and includes all interest 48
income, service charges, carrying charges or time-price differential charges incidental to such sales. Federal and state excise taxes (including sales taxes) shall be included as part of such receipts if such taxes are passed on to the buyer or included as part of the selling price of the product.
ii. Sales Factor – Sales Incidental To General Business Operations (17 NCAC 05C.1002)
As a general rule, “sales” also includes gross receipts derived by a taxpayer from business transactions or activities which are incidental to its principal business activity and which are includable in apportionable income. However, substantial amounts of gross receipts arising from an incidental or occasional sale of a fixed asset used in connection with the taxpayer’s regular trade or business will be excluded from the sales factor since such sales constitute a “casual sale” of property and the inclusion of such gross receipts will not fairly apportion to this State the income derived by the taxpayer from its business activity in this State. For example, gross receipts from the sale of a factory or plant will be excluded from the sales factor but the gain or loss on the sale will be included in apportionable income.
Likewise, the “proceeds” from “rollover” of working capital invested in certificates of deposits, money market accounts, etc., on a short-term temporary basis are not considered gross receipts for sales factor purposes. The earnings of such investments whether labeled as gains or interest will be the only amounts includable in the sales factor.
In including or excluding gross receipts, the taxpayer shall be consistent in the treatment of such gross receipts in filing returns with this State. In the event the taxpayer is not consistent in its reporting, it shall disclose in its return to this State the nature and extent of the inconsistency.
iii. Sales Factor – Sales Made In Other Types of Business Activity (17 NCAC 05C.1003)
As applied to a taxpayer engaged in business activity other than the manufacturing and selling or purchasing and reselling of property, “sales” includes the gross receipts as defined in this subject.
If the business activity consists of providing services, such as the operation of an advertising agency, or the performance of equipment service contracts, research and development contracts, “sales” includes the gross receipts from the performance of such services including fees, commissions, and similar items including prepaid amounts for these services.
In the case of cost plus fixed fee contracts, such as the operation of a government-owned plant for a fee, gross receipts includes the entire reimbursed cost, plus the fee.
If the business activity is the renting of real or tangible personal property, “sales” includes the gross receipts from the rental, lease, or licensing the use of the property. 49
If the business activity is the sale, assignment, or licensing of intangible personal property such as patents and copyrights, “sales” includes the gross receipts therefrom.
iv. Sales Factor – Numerator (17 NCAC 05C.1004)
The numerator of the sales factor will include the gross receipts from sales which are attributable to this State, and includes all interest income, service charges, carrying charges, or time-price differential charges incidental to such sales regardless of the place where the accounting records are maintained or the location of the contract or other evidence of indebtedness.
Where a taxpayer is not taxable in another state on its apportionable income but is taxable in another state only because of nonapportionable income, all sales shall be attributable to this State.
v. Sales Factor – What Sales of Tangible Personal Property Are In This State (17 NCAC 05C.1005)
Gross receipts from the sales of tangible personal property are in this State if the property is delivered or shipped to a purchaser within this State regardless of the f.o.b. point or other conditions of sale.
Property shall be deemed to be delivered or shipped to a purchaser within this State if the recipient is located in this State, even though the property is ordered from outside this State.
Example: The taxpayer, with inventory in State A, sold one hundred thousand dollars ($100,000) of its products to a purchaser having branch stores in several states including this State. The order for the purchase was placed by the purchaser’s central purchasing department located in State B. Twenty-five thousand dollars ($25,000) of the purchase order was shipped directly to purchaser’s branch store in this State. The branch store in this State is the “purchaser within this State” with respect to twenty-five thousand dollars ($25,000) of the taxpayer’s sales.
Property is delivered or shipped to a purchaser within this State if the shipment terminates in this State, even though the property is subsequently transferred by the purchaser to another state.
Example: The taxpayer makes a sale to a purchaser who maintains a central warehouse in this State at which all merchandise purchased is received. The purchaser reships all the goods to its branch stores in other states for sale.
All of the taxpayer’s products shipped to the purchaser’s warehouse in this State are property “delivered or shipped to a purchaser within this State.”
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The term “purchaser within this State” shall include the ultimate recipient of the property if the taxpayer in this State, at the designation of the purchaser, delivers to or has the property shipped to the ultimate recipient within this State.
Example: A taxpayer in this State sold merchandise to a purchaser in State A. Taxpayer directed the manufacturer or supplier of the merchandise in State B to ship the merchandise to the purchaser’s customer in this State pursuant to the purchaser’s instructions. The sale by the taxpayer is “in this State.”
When property being shipped by a seller from the state of origin to a consignee in another state is diverted while in route to a purchaser in this State, the sales are in this State.
Example: The taxpayer, a produce grower in State A, begins shipment of perishable produce to the purchaser’s place of business in State B. While in route the produce is diverted to the purchaser’s place of business in this State where the taxpayer is subject to tax. The sale by the taxpayer is attributed to this State.
vi. Sales Factor – Sales To United States Government (17 NCAC 05C.1006)
Gross receipts from the sales of tangible personal property to the United States Government are in this State if the property is shipped to or received or accepted by the United States Government in this State. For the purposes of this regulation, only sales for which the United States Government makes direct payment to the seller pursuant to the terms of its contract constitute sales to the United States Government. Thus, as a general rule, sales by a subcontractor to the prime contractor, the party to the contract with the United States Government, do not constitute sales to the United States Government.
Example 1: A taxpayer contracts with General Services Administration to deliver X number of trucks which were paid for by the United States Government. The United States Government is the purchaser.
Example 2: The taxpayer is a subcontractor to a prime contractor with the National Aeronautics and Space Administration and contracts to build a component of a rocket for one million dollars ($1,000,000). The sale of the subcontractor to the prime contractor is not a sale to the United States Government.
When the United States Government is the purchaser of property which remains in the possession of the taxpayer in this State for further processing under another contract, or for other reasons, “shipment” is deemed to be made at the time of acceptance by the United States Government.
vii. Sales Factor – Numerator – Other Receipts Constituting Apportionable Income
G.S. § 105-130.4(l)(3) contains provisions for including gross receipts from other business income transactions in the numerator of the sales factor. Under this subsection gross receipts are attributed to this State, if: 51
1. The receipts are from real or tangible property located in this State; or
2. The receipts are from intangible property and are received from sources in this State; or
3. The receipts are from services and the income producing activity that gave rise to the receipts is performed within this State.
The term “income producing activity” means the act or acts directly engaged in by the taxpayer, or by anyone acting on the taxpayer’s behalf, in the regular course of its trade or business for the ultimate purpose of obtaining gains or profits.
Except for receipts from the casual sale of property, as defined above, receipts described above from other transactions constituting apportionable income shall be attributed to this State as set forth below:
1. Gross receipts from the sale, lease, rental or other use of real property are in this State if the real property is located in this State.
2. Gross receipts from the sale of electricity if the location of the income producing activity is located in this State.
3. Gross receipts from the rental, lease, licensing the use of, or other use of tangible property shall be assigned to this State if the property is within this State during the entire period of rental, lease, license or other use. If the property is within and without this State during such period, gross receipts attributable to this State shall be based upon the ratio which the time the property was physically present or was used in this State bears to the total time or use of the property everywhere during such period.
4. Gross receipts from intangible personal property shall be attributed to this State if they are received from sources within this State.
Example 1: Royalties from trademarks are attributed to this State to the extent the royalties are used in this State.
Example 2: Royalties from patents, secret processes, or other similar intangible property are attributed to this State to the extent the patent, secret process, or other similar intangible property is employed in production, fabrication, manufacturing, processing, or other similar use in this State.
Example 3: Royalties from copyrights are attributable to this State to the extent that printing or other publication originates in this State.
Example 4: Dividends are attributable to this State if the payer’s commercial domicile is in thi